Political Affiliation and Investment Returns – Is There A Link?

With the Republican primary well under way, I’m sure you may be wondering which candidate will be able to revive the U.S. economy and push markets back into bull territory. Over the years, the debate between politics and financial growth has been contentious, questioning whether Democratic or Republican policies are more beneficial for the economy and financial markets.

As we sit at a crossroads wondering whether Obama’s Keynesian approach through fiscal stimulus or a non-interventionist approach á la Reagan from a new president will put the U.S. back on a growth trajectory, will it ultimately have any impact on our investment portfolios?

Perhaps the successes of one administration that result in bull markets are simply the product of the previous administration. Meanwhile, some contend that markets will perform better under Republican presidencies because they are perceived to institute economic policies deemed advantageous to markets.

To get an understanding of some of the theories out there, let’s look at some of the financial literature.

In a 2003 Journal of Finance paper, researchers found that markets have higher returns under a Democratic presidency than a Republican presidency, stretching back to 1927. There is a caveat however – the differences in returns aren’t bunched around election periods and are primarily due to unexpected factors that economic and political factors don’t capture.

Thus, their results indicate that political party switches don’t necessarily explain superior performance during Democratic presidencies. In essence, there is a correlation between political affiliation and investment returns, but no evidence of political affiliation causing differences in investment returns.

On a more nuanced level, a recent working paper shows that industries with greater government exposure (i.e. Defense contractors) have higher stock returns under Democratic presidencies than during Republican presidencies. Interestingly, the effect is especially significant during the middle of the presidential term rather than at the beginning when the switch is made. Furthermore, whether political affiliation directly influences stock market returns isn’t completely resolved as other factors are also influential.

While there might be an association between political affiliation and stock market returns to an extent, trying to time the market is very difficult. For instance, take a look at Table 3 in this article. Each strategy results in very different investment outcomes, but the investment horizons seem rather arbitrary. With backward-looking bias, it’s relatively easy to identify “successful” patterns, but to assume those trends will continue on a forward-looking basis is misguided.

In this type of volatile environment, relying on historical relationships can have disastrous consequences despite the fact that Democratic election cycles have often become more fruitful for investors. One on hand, the S&P 500 has gone up over 60% since Obama took office. Perhaps one could attribute this performance to his policies despite the fact that unemployment and housing have remained in a quagmire. However, it’s also possible that these equity run-ups are due to quantitative easing, something I previously alluded to.

During George W. Bush’s reign from January 2001 to January 2009, the S&P 500 fell over 42%,  most of which occurred at the onset of the financial crisis in mid-to-late 2008. Therefore, at this point, it is a very difficult exercise to specifically identify the determinants of stock price appreciation and politics may only be indirectly related where the lag effect of economic policies may play a role.

With the presidential election still a long way off, there’s no guarantee that a Republican president in the White House or an incumbent Democrat will determine the investment landscape. I prefer to focus on the here and now where Europe is the primary concern that will most likely affect most movements in equity ETFs. I won’t be basing my investment decisions on political election cycles – that’s for sure.