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US politics and stock markets

The U.S. presidential election is a highly anticipated event that garners much of the public’s attention. Major news outlets put huge efforts into reporting, discussing and debating the merits of the candidates, parties and policies put forth.

Americans (and Canadians for that matter) are highly engaged in finding out who the next "leader of the free world" will be, and how potential outcomes will affect them. In this article we try to gain insight into the following two questions:

  1. Historically, which party has the stock market preferred?
  2. How sensitive is the market to presidential elections?

S&P 500 and Presidents

Under which American party has the stock market performed better historically? Analyzing historical and current platforms for the Democratic and Republican parties, one could conclude that market participants should have a favorite:

Although these lists of platform positions are far from exhaustive, they are representative of the fact that Republicans have been known historically as the “party of Wall Street”. To test this hypothesis, we analyzed the S&P 500 from the election of Herbert Hoover to the present, and measured which party has been the better performer on an annualized basis3. The results are summarized in the figure below:

To get a better idea of how the price index translates into returns, Table 1 shows the annualized returns for each presidential term. This result was quite profound, so we further tested the results by removing outliers for both parties. In particular, the annualized returns were measured without the highest and lowest return for each party (for example, Herbert Hoover was not measured). The difference was still fairly significant, with the Democrats at 9.78% annualized and the Republicans at 3.14% annualized.


The VIX and Election Periods

We then explored the volatility of equity markets in times of elections. Given market uncertainty during elections, we set out to measure how volatile the S&P 500 was in election years versus non-election years. One method to measure volatility is to use the Chicago Board of Options Exchange Volatility Index (VIX). Roughly speaking, the VIX measures the market expectation of near term volatility (30 days) conveyed by a basket of S&P 500 index options with various strike prices4. The VIX was created in 1993, and backfilled to the beginning of 1990. We used a similar methodology to run the U.S. market volatility back over 80+ years.

At first glance, election periods appear no more volatile than non-election periods, with the exception of the 1932 and 2008 elections. However, the volatility in both these time periods would have been further exacerbated by credit problems, which are more likely attributable to this fact. For further illustrative purposes, Table 2 shows the average values of the VIX one month and one year before the election, and three years after the election during the past twenty years. Clearly, there does not appear to be much support to the argument that equity markets in the U.S. become more volatile leading up to an election.


Additional Considerations

If the current market looks eerily similar to the markets of the 1930s, then there may very well be continued volatility on the horizon and an “austerity piece”. This would coincide with the argument that the U.S. needs to find some way to reduce its debt levels before the markets resume with confidence. Interestingly enough, it took many years after the 1930s before interest rates began rising. Like today, many investors then believed rates to be at all-time lows with nowhere to go but up. Investors might be wise to expect nothing but a modest increase in rates in the near future; large increases may be far off or even a pipe dream at best. The biggest problem facing both parties is the unprecedented debt level the United States government continues to add to with no solution agreed upon between parties.

Conclusion

Looking at the data, two points jump out: the S&P 500 has fared far better under a Democratic regime than a Republican one, and election uncertainty does not necessarily spillover into stock market uncertainty. So, even though following the Romney and Obama campaigns makes for good entertainment, don’t plan on trying to capitalize on any indeterminacy in the market over the short term. Expect to hear more about taxes and debt levels over the coming month and try not to get too caught up in the market noise that is unfairly attributed to the election. Investors should maintain well diversified portfolios and look to reduce unwanted risks where possible. This U.S. election, like others before it, should not persuade investors off the long-term path.


1 http://www.democrats.org/democratic-national-platform
2 http://www.gop.com/2012-republican-platform_home/
3 The annualized performance was measured from election dates, and not based on the actual inauguration, which occurs approximately three months after the election date.
4 http://www.cboe.com/micro/vix/faq.aspx