Presidential Puzzle

Ponder this election-year mystery: Does it matter to the stock market which political party controls the White House?

Let’s take a stab at that question.

For starters, the stock market has fared better under Democratic administrations, for the most part. That’s a contrarian happenstance. Mutual fund colossus Fidelity’s research unit reminded us early this year, the “common perception” over the past few decades has been that the market prefers the Republican Party’s stress on deregulation, lower taxes, and limited government.

“Of course, that would be the natural interpretation,” says John Boyd, a finance professor at the University of Minnesota’s Carlson School of Management. “Few of my neighbors here in Wayzata are going to vote for Obama.”

In October 2003, Pedro Santa-Clara and Rossen Valkanov, then finance professors at the University of California in Los Angeles, published one of the most frequently quoted studies of this matter. Their analysis, “The Presidential Puzzle: Political Cycles and the Stock Market,” appeared in the Journal of Finance.

What the Studies Show

The two researchers examined the difference between a broad, capitalization-weighted index of stock prices and three-month Treasury bill rates during presidencies stretching from 1927 to 1998. Their data came from the Center for Research in Security Prices. They adjusted the prices for inflation. Their conclusion: The stock market produced average returns of 11 percent more than the T-bill rate under Democrats versus 2 percent more under Republicans.

While they have not updated their research, both note that this pattern has continued since 1998.

The Standard & Poor’s (S&P) 500 index clearly confirms that. It nearly tripled to 1,229 by the December 31, 1998, end date for the Santa-Clara and Valkanov study—midstream through Democrat Clinton’s second term—from 433 when he was first elected in 1992. By election day of 2000, it had climbed on up to 1,432.

But now, the S&P 500 faces a struggle to get back to where it was when the voters chose Bush. On September 30 of this year, the index closed at 1,165—down 19 percent from when Bush was first elected. Of course, the market’s convulsions lately make this bedrock index somewhat variable now.

The Santa-Clara and Valkanov study has its critics. Some argue that the relatively small number of presidential terms studied limits the value of the data. In 2006, a quartet of finance professors from Vanderbilt University, the Australian National University, and Massey University in New Zealand questioned the study’s methodology.