Friday, November 9, 2012

Financial Markets and President Elect: Do Financial Markets Favor A Republican Over A Democrat?

US financial markets favor a republican president over a democratic president. Has this sentiment stood the test of time?  Do financial markets care whether the president elect is a democrat or a republican?  How have financial markets behaved in the past after the announcement of next US president?  And finally, can one spot a pattern in the performance of financial markets based on the president's party affiliation?  More specifically, did financial markets fare better under a republican president or under a democratic president?

To answer all these questions, I turned to history and generated the historical performance of S&P 500 since 1952.  I also had to turn to Wikipedia to get a list of presidents and their party affiliation.  Between 1952 and 2012, US has elected 16 presidents with republican presidents outnumbering their democratic counterparts by 2 in occupying the white house (see table below):

To understand whether financial markets favored a republican president over a democratic president, I generated 1-day, 1-week, 4-week, 12-week, 52-week and the presidency term ("term") returns since the election date (see table above.)  Looking at the one day return, there was no clear indication whether markets favored one party or the other.  Financial markets welcomed Ronald Reagan, a republican, by sending the S&P 500 up 1.77% which is the highest one-day return among all the 16 presidential events.  Markets also cheered the reelection of Bill Clinton with a one-day return of 1.46% after the announcement of president elect.

Source: AllThingsAnalytics
With one-day returns of -5.27% and -2.37% in 2008 and 2012 respectively, President Obama is not much favored by financial markets.  Now, one can argue that October 2008 was a terrible period for anyone to be elected as the president because of the ongoing crash in financial markets that led to the great recession (see side chart.)  Nonetheless, markets also didn't like Obama's reelection (S&P 500 was down 2.37% following the election day) which leads to a status quo in Washington.  Combine that with all the ongoing macro concerns including the Euro debt crisis and already unraveling fiscal cliff, investors have become very jittery in the past couple of days.

Now, to overcome the short-term bias in financial market's reaction, let's review other period's returns (see table above.)  There are plenty of interesting observations one can make.  For example, under both of Clinton's (Democrat) presidencies, financial markets boomed with returns of 56% and 111% over the next 200 weeks since the election day.  Eisenhower's (Republican) presidency came second with returns of 95% and 19%.  Reagan era followed by Bush Sr's term also produced hefty gains for investors with returns of 28%, 56% and 49% under their terms.  Again, there is no clear indication whether financial markets favored one party over the other during a president's term in the office but financial markets definitely fared well under a republican president prior to 2000.

Bush Jr. (Republican) inherited dot-com crash, oversaw the biggest expansion in US public debt (see chart below) and observed the epic housing crisis of 2007-2008.  Financial markets yielded returns of -22% and 13% during Bush's two terms presidency, pretty poor for a republican president who unleashed all the expansionary polices on US economy.  Under Bush's 8 year presidency, US public debt doubled from $5.6 trillion to $10 trillion.  Obama added almost the same level of debt in just 4 years and took US public debt from $10 trillion to $14.2 trillion by the end of 2011.

Source: AllThingsAnalytics

From Wikipedia, click to expand

Are we living in times which have no historical precedence?  It took 20 years for US public debt to rise from $1 trillion level to $5.5 trillion level (see side chart).  It then just took 11 short years for US public debt to rise to $14 trillion level.  From year 1980 to 2000, S&P 500 appreciated by 1276% (from 105 at the start of 1980 to 1455 at the start of 2000). Astonishing rise!!!   Also astonishing is the fact that since 2000 till date, S&P 500 has been down -5%.  Has the mammoth economic expansion of 1980s and 1990s run its course and now debt is the only route left to sustain US economy.  Let's leave this discussion for another blog.

Financial markets care less which party's candidate is elected for the white house and focus more on the economic policies that president will enact.  All the rhetoric and party ideology does take a toll on financial markets though as evident in financial markets' immediate reaction similar to the one we are observing right now.  Hopefully, the congress and the president will put the rhetoric aside and break the impasse on the already unraveling fiscal cliff.

This blog has benefited from discussions with Jens DoerpmundRyan Leask and Rajani Aswani on this topic.

Disclaimer:  All numbers are approximate and the underlying analysis is preliminary.  This blog is not intended for offering any investment advice.