Presidential Elections and the Stock Market

Economists have done a lot of research on how U.S. presidential elections affect the stock market.  Most of the studies show quite an advantage for equities following the election of Democrats, but a Federal Reserve study concludes there is no consistent relationship if you correct for market volatility and test back to 1852. 

The most cited paper was published in the Journal of Finance in October, 2003 by two University of California economists, Pedro Santa-Clara and Rossen Valkanov.  They found 9% higher stock market gains for large stocks in Democratic administrations since 1928. 

However, Santa-Clara and Valkanov did not correct for swings in market volatility or examine periods before the Depression, when market volatility was lower. In a 2004 paper, two Federal Reserve economists, Sean Campbell and Canlin Li, made those corrections and found that the 9% higher return dropped to 4%.  They concluded that market returns don't track with which party wins presidential elections.

Vanguard published an excellent summary of this econometric work on October 23, 2008.  In particular, look carefully at Figure 1.  It shows that the stock market rose in every year since 1940 and that the massive rebound in 1933 from the lowest levels of the Depression overly influenced the results. It also shows that, after the Depression, the stock market grew almost equally in Republican and Democratic administrations if you drop the 1974 recession (caused by the first energy crisis, which was hardly President Nixon's fault) and the 2001 recession (which was in progress before President Bush 43 took office).  Figure 2 shows that the stock market return since 1852 has been virtually the same for Republicans at 8.66% and for Democrats at 8.97%.

This year, we've seen nothing like the decline of 1929, but we've seen enough of a decline for some to hope for a big rebound soon. Check out this handy list of big swings in the Dow Jones average courtesy of Wikipedia.  Anything is possible, but I would look for some "selling on the news" of today's election over the next few days and for distinctly negative market reaction to Friday's employment report and Monday's GM earnings (rather massive loss) report. In my opinion, a strong market rebound in the next six months will only occur if stock market participants gain a lot more confidence than they have now that further stimulus and judicious use of Treasury's $700 b. TARP ("Troubled Asset Relief Fund") will remedy the credit crisis and restore economic growth.