Weekend Reading: Party vs. Market

Dear Clients & Friends,

Here we begin what may be a painful, but hopefully informative, discussion about the coming midterm elections.  Read this, it my surprise, you, A LOT!

We have three topics to discuss:

  1. Will the midterm elections result in a congressional swing towards the Democrats?

  2. Could such a political swing shock the markets due to the popular opinion that Republicans are better for the investment markets than Democrats?

  3. Is this popular opinion that Republicans are better for the investment markets true?

First, we have no idea if such a swing will happen, so let’s just glaze through this one. Recent special elections have shown some surprising results in favor of the Democratic Party. However, even the most recent polls are too early and too split to be of any significance to our opinion.  We hope that polling in September and October gives us better foresight, and we’ll keep you posted.

Second, if Democrats took the majority in Congress, we at MOR Wealth Management fear that a shock to the investment markets could occur due to the popular opinion that I mentioned above- that Republicans are pro-business and Democrats are not.  We think that, with a Democratic swing, there is a strong possibility that investors may sell out of their portfolios in expectation of market volatility. The ensuing market decline could cause deeper fears and more massive liquidations, resulting in a self-perpetuated 10 to 20% market correction. In addition, many analysts believe that we are nearing the end of the current Bull market. Therefore, even a small fear-based correction could be interpreted as this end, which is another possible instigator of a more widespread and elongated market fall. 

An additional factor that may exacerbate market tensions is the tariff war, which has started to cause problems for many American businesses, particularly in the agricultural sector. Hopefully it can be won swiftly or called off altogether because a prolonged tariff war presents a true and present threat to economic growth in in any economy.

I plan to write more about the tariff war soon, but for the time being, I’ll mention one example of why a prolonged tariff war presents a risk to our client portfolios. The World Trade Partnership Worldwide, an economic consulting firm in DC, recently reported their expectation that the steel tariffs could create 27,000 new jobs in the steel industry, but could cost 400,000 jobs in other industries.  The reason for this is because the steel tariffs help the steel production industry, but hurt any industry that requires the purchase of steel. If the cost of a particular good made from steel rises, its profits fall.  If profits fall, earnings per share (EPS) falls, which usually leads to a drop in stock prices.  But more on that later.

Here is the really interesting part of this weekend’s reading…

For quite some time, there has been a notion in the USA that Republicans are good for business and the investment markets and Democrats are not.  But regardless of this belief, do the markets, and therefore personal investment portfolios, perform better under a Republican president? 

The most compelling research was conducted by Pedro Santa-Clara and Rossen Valkanov, who published their results in The Journal of Finance in October 2003 ("The Presidential Puzzle: Political Cycles and the Stock Market"). This analysis of stock market returns is widely used as a foundation for academic research due to its clear, unbiased, and systematic approach using major market indexes.

Unlike most studies of this nature which are based on total returns. Santa-Clara and Valkanov based their analysis on the average excess return of the indexes over the return of the three-month Treasury bill.  Although beyond the scope of this article, this approach, to some extent, negates the effect of inflation and the economic conditions prevalent at the time a president took office. Therefore, the research is more reflective of a particular president’s legislation rather than a head wind or tail wind created by a previous administration. The results were striking!

When a Republican president held office, the value-weighted return delivered nearly a 2% premium over the T-bill. When a Democrat held office, the premium was nearly 11%. While the 9% difference clearly favors the Democrats, the results from the equal-weighted portfolio were even more telling, with a 16%+ result in favor of the Democrats.

*Investopedia

In addition, the research indicates that the results were generated by higher real returns and lower interest rates under Democratic administrations. Investopedia also concludes that, due to the “excess return” approach mentioned above, business cycle fluctuations showed no correlation to the results, demonstrating statistically significant outperformance for the Democrats regardless of underlying economic conditions.

Below is a chart from Bloomberg that shows the average un-weighted stock market return from Herbert Hoover’s administration until 2013. This data better illustrates the long-term effects each party has had on the stock market. It extends 10 years beyond Santa-Clara and Valkanov’s research and yields nearly identical results.

One issue I have with the chart above is that this particular data set shows 2 additional terms with a Democratic held Presidency vs Republican.  However, even if we adjust for that imbalance, the data materially contradicts the popular notion that Republicans are pro-market and that Democrats are not so pro-market.

Regardless of the reputations of each of the parties, I, for one, was surprised at how compelling the ‘market vs party’ data is. So, let us return to the three questions at hand.

1) Will the midterm elections result in a congressional swing towards the Democrats?

We don’t know yet.  Hopefully we’ll know more soon.

2) Could such a political swing shock the market due to the popular opinion that Republicans are better for the investment markets than Democrats?

Yes, we believe it could.

3) Is this popular opinion that Republicans are better for the investment markets true?

No.

Have a lovely weekend.

-MR


Matthew Ramer, AIF®
Principal, Financial Advisor
MOR Wealth Management, LLC

1801 Market Street, Suite 2435
Philadelphia, PA 19103
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matthew.ramer@morwm.com | www.morwm.com

The majority of this content was written and distributed MOR Wealth Management, all rights reserved. Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a registered investment adviser. Fixed insurance products and services offered through CES Insurance Agency.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results.