What Markets Get Right (and Wrong) About Campaigns

(Bloomberg) -- It happens every year: a political race heats up, and investors become obsessed with how it’s playing in the equity market. In the U.S., that means that when a Republican pulls ahead, there will be voices saying that must be good for stocks. Sudden losses in a marquee industry like banks send analysts scrambling to find the policy or campaign pledge to blame. But while it makes for lively dinner conversation, it’s wise to take everything in this realm with a grain of salt. Simply put, the market’s knee-jerk reactions to political news are notoriously volatile and often wrong. And in the end it’s never clear if politics is influencing stocks, stocks are influencing politics or if everything is getting pushed around by something else entirely.

1. How smart is the market about politics?

Looking at the reaction to Barack Obama’s first election, his re-election, and Donald Trump’s defeat of Hillary Clinton, it’s hard to call it omniscient. Each of those victories was met with panic by traders. The S&P 500 fell 5.3% on Nov. 5, 2008, and 2.4% on Nov. 7, 2012, after Obama’s wins. When it became clear Trump would prevail four years later, index futures tumbled the maximum allowed by exchanges in a matter of minutes. And each time, the initial direction was dead wrong. Under Obama and Trump, a bull market has added $28 trillion to equity values.

2. Surely it matters who’s president?

While there are obvious instances of both White House policy and scandal influencing shares in the short term, boiling out the lasting effect of presidents on markets is far murkier. Consider Ronald Reagan’s 1981 tax cut, enacted at the start of a five-year rally that lifted the S&P 500 by 229%. That’s certainly how his supporters cast it at the time. In hindsight, economists are inclined to put as much or more weight on other factors. Most notably, Federal Reserve interest rates were falling from 20% to below 9% under Chairman Paul Volcker. The partisan leanings of presidents doesn’t seem to matter much, either. The median S&P 500 gain in Democratic terms since 1928 has been 27.7%, according to Leuthold Group LLC, compared with 30.2% under Republicans.

3. But obviously Donald Trump has been good for stocks, right?

It’s certainly true that equities have been buoyant under the 45th president, rising 56% since election day, but arguments that they have been exceptional under him are a little shaky. Here is a list of administrations that saw three-year advances in the S&P 500 close to or greater than this one:

• Bill Clinton’s second term. (99%)
• Franklin Roosevelt’s first term. (98%)
• Dwight Eisenhower’s first term. (82%)
• Clinton’s first term. (51%)
• George H.W. Bush’s term. (49%)
• Reagan’s second term. (47%)

Stocks have a strong propensity to rise. Saying anything more is pushing it.

4. But a market this strong makes re-election a sure thing, right?

It’s easy to imagine this is true but enough counterexamples exist to complicate the calculus. Stocks climbed sharply in Obama’s second term and yet the Democrats lost their bid to hold onto the White House. In 2000, Democrats were the incumbent party but were booted out after one of the biggest rallies ever. More than the market, it’s the economy that sets the tone. Recessions can be detrimental for the party in power. In the last century, the only elected presidents who lost re-election did so after overseeing a recession — George H.W. Bush in 1992, Jimmy Carter in 1980 and Herbert Hoover in 1932.

5. OK, so what can we say about politics and the market?

There’s reason to believe the performance of stocks does affect voters’ opinions about the economy and the party in power, at least at the margin. According to a recent academic study, rising stocks tend to work in favor of the incumbent party, though not to the exclusion of all else (again, see 2016 and 2000.) What the researchers found was statistical evidence that when the market is up over the period since the last election, people who own the most stock tend to favor the incumbent.

6. If investors want to get an early read on elections, is the market of any help?

There is one lens through which the S&P 500 has a record of prescience that perhaps no human forecasters can match. Since 1928, the benchmark index has correctly signaled who will win, the candidate of the incumbent party or challenger, 20 out of 23 times, according to data compiled by Strategas Research Partners LLC. That is, when stocks are higher during the immediate three-month span before a vote, the sitting party has won 86% of elections.

The Reference Shelf

• Bloomberg Opinion columnist Ramesh Ponnuru’s take on the economy and the 2020 presidential election.
• Bloomberg Opinion columnist John Authers argues that the Trump rally in stocks is nothing more than luck.
• The economy in early voting states is working in Trump’s favor but some swing states have lost manufacturing jobs because of his trade war.
• The Washington Post’s analysis of the impact of Reagan’s 1981 tax cut.
• A QuickTake on how the U.S. elects its president.
• A Federal Reserve discussion paper on why stocks have risen so much since Trump’s election.
• A University of Chicago research paper on “Political Cycles and Stock Returns”

To contact the reporter on this story: Lu Wang in New York at lwang8@bloomberg.net

To contact the editors responsible for this story: Brad Olesen at bolesen3@bloomberg.net, Chris Nagi, John O'Neil

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