Exit polls haven’t shed any light on which candidates have cornered the key one-year old vote. Photo by Scott Olsen/Getty Images.
Editors’ Note: Our discussion of politics and elections is focused purely on potential market impact. Stocks favor neither party. Believing in the market/economic superiority of one group of politicians over another can invite bias—a source of significant investment errors.
Here is a statement we hear all the time in election years: “I hope So-and-So wins because So-and-So is exactly what our economy needs to start growing fast again!” Indeed, at last week’s debates and the many whistle stops before and after, all the remaining candidates spouted off about what they will do to improve the economy once they’re in the White House. Parallel to that, we’ve seen a fair amount of hypothesizing on which candidate or party will be best for the economy and stocks. Yet neither have such a huge influence. Most pledges either never come to fruition or are heavily watered down. What’s more, politics are only one factor of many driving market returns. Love or loathe any candidate’s economic proposals, making investment decisions based solely on the personality or party controlling the White House is a prescription for errors.
In election years, investors regularly cheer or jeer every new administration—depending on their political leanings—thinking it will be either economic magic or poison. But for good or ill, most candidates’ campaign pledges never become reality. Just consider the last four presidents. Barack Obama planned to jumpstart a renewable energy boom while imposing a windfall profits tax on oil companies. George W. Bush (Bush 43) proposed partially privatizing Social Security and paying down a chunk of the federal debt. Bill Clinton sought national, single-payer health care, support for factories and increased manufacturing employment. George H. W. Bush (Bush 41) aimed to keep taxes low.
None of these happened. Solyndra, the Obama administration’s green darling, went bankrupt (along with a few others) and that windfall profits tax was blown away. Social Security is as public as ever, and US debt rose under Bush 43. Factory jobs fell under Clinton, and national health care reform didn’t come until 18 years after his election—and only then in a very watered-down form. Bush 41 famously violated his signature pledge of, “Read my lips. No new taxes!” Anyone basing investment decisions solely on these folks’ flagship campaign pledges would have been sorely disappointed.
Despite this history, partisan bias often leads investors to overrate politicians’ promises—and their impact. Many Republican-leaning investors, taking traditional campaign rhetoric at face value, believe their party is inherently pro-business and therefore better for stocks—and that Democratic presidents tend to be bad for stocks. Democratic-leaning investors, by contrast, cite strong returns under Democratic Presidents to support their bullishness, noting the historically subpar results under Republicans.
Exhibit 1: Returns by President/Party
Source: Global Financial Data, Inc., as of 3/11/2016. S&P 500 price returns, 3/4/1929 – 3/9/2016. Red font indicates Republican administration, blue font Democratic. We present this with Kennedy/Johnson and Nixon/Ford separate (italicized) and combined (boldface), as the administrations sum to one eight-year period of uniform party control, despite the non-election change in President amid both.
Contrary to common fears, no party is “bad for stocks.” Democratic administrations have coincided with fine returns, gutting the notion they are bad for stocks. Since 1926, in years the US has had a Democratic President, stocks rose 79% of the time. But then again, Republican administrations coincide with positive returns most of the time, too (67%). Now, all that may seem to favor the Democratic argument. But that is far too narrow a view. While neither Democrats nor Republicans are categorically “bad for stocks,” these data can’t and don’t prove either party’s superiority.
Take Hoover’s returns. (And don’t bring them back, please.) Markets fell a lot under him, and he made some mistakes, for sure. (Signing the Smoot-Hawley Tariff Act of 1930 chief among them.) But as Milton Friedman and Anna Schwartz showed in their seminal work, A Monetary History of the United States, the Fed’s overly tight monetary policy was the primary culprit for the massive economic downturn and -77.1% S&P 500 returns from 1929 – 1933. This theory is widely accepted today. Former Fed head Ben Bernanke put it well in concluding a 2002 speech celebrating Friedman’s 90th birthday: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.”
Roosevelt’s returns might look wonderful—and they are far better than Hoover’s—but he was in office 12 years. When you compare annualized returns during his presidency (7.5%), they trail returns during Bush 41 (10.9%), Reagan (10.2%) and Eisenhower (10.9%).[i] Moreover, Bush 43 took office in 2001, 10 months into the dot-com bear, which began in Clinton’s last year in office. Reagan also took office on the cusp of a bear that began under Jimmy Carter. And, while the Bush 43 administration’s haphazard response to the global financial crisis contributed to the depth of the downturn in 2008, FAS 157 (the mark-to-market accounting rule implemented in 2007) wasn’t a Bush 43 administration-led policy—it was a rule passed by the Financial Accounting Standards Board, a body designed to be independent of administration directives.
Markets soared under Clinton, but this was largely due to a Technology boom that he had little to do with. The beginnings of the Internet’s commercialization spawned a boom in personal computers, e-Commerce and Internet infrastructure. Moreover, Clinton dealt with gridlock from 1994’s “Republican Revolution” through the close of his presidency. Similarly, while markets have done well under Obama (annualizing 12.7%), consider: He has operated under gridlock since January 2011, and he came to office near the trough of one of history’s worst bear markets. Absent a counterfactual, it isn’t possible to know for sure what would have happened had McCain won. Maybe the bounce would have been bigger. Or smaller. Or the same. After all, when bear markets end, stocks historically tend to bounce big.
Maybe this last point strikes you as odd, but consider: The ultimate reason thinking partisan is wrong in investing is that America’s economy is dominated by the private sector. (Exhibit 2) The bulk of our economy is outside the control of the folks in DC. Perhaps that strikes you as a thunderclap of duh. That’s fine, but thinking the president you love or hate is going to fundamentally alter the course of hiring, output, wages, exports, stock prices, or, or, or, overlooks this point. What’s more, the US is only about 25% of global GDP today. That means 75% of world economic activity isn’t subject to an administration’s policies[ii], whatever they are. Finally, equity market results are often the result of how sentiment compares to reality. If investors generally fear President So-and-So will be awful for stocks, anything better than awful will be a positive surprise. That may not be the most patriotic sentence you’ve ever read, but markets are unemotional.
Exhibit 2: Private Sector and Government Share of US GDP, as of 2014
Source: FactSet, US Bureau of Economic Analysis, as of 3/14/2016. 2014 annual data are the latest available as of this writing.
None of this is to say politics and presidencies are irrelevant. As one major driver of stock returns, it would be foolish to conclude there is no impact from government. Politicians can affect market direction through passing sweeping legislation. Or they might influence performance at the sector level. From 2009 – early 2011, while the Affordable Care Act debate and initial passage created uncertainty, Health Care stocks lagged the US market. But after it became reality, stocks moved on and Health Care outperformed.
There is also a big impact on sentiment in election years: Typically, US markets post above-average returns in years a Republican wins—as the Republican-leaning investor class anticipates a business-friendly administration. When they turn out to be politicians,[iii] post-inauguration, disappointment tends to weigh on returns. Election year returns tend to be below average when Democratic candidates win, but rebound on relief when they prove to be politicians,[iv] too. This year, we have a weird election dotted with outsiders and untraditional candidates, making us wonder if these trends apply—a factor we’ll continue weighing as this year progresses.
We have no idea today who will wind up winning the White House next January. But we do know that whomever you plan to vote for isn’t hugely relevant to how you invest. When it comes to assessing markets’ likely direction, your portfolio should be registered independent.
[i] Source: Global Financial Data, Inc., as of 3/10/2016. S&P 500 price returns for the administrations indicated.
[ii] Except, of course, where international trade is concerned.