Dear Paul,

How will the presidential election affect the economy?

We are now living through the most serious economic crisis since the Great Depression.  Warren Buffett has called this crisis the economic equivalent to Pearl Harbor.

The economy clearly affected the presidential race.  But how will the election results affect the stock market?

It is true that past performance is no indication of future performance, but it’s hard to resist looking back at how the markets have responded to presidential politics.

Stock market consultant and analyst Barry Mendelson has written about this issue and has put together the following statistics and trends:

Who’s Voting? 

This year's record-setting voter turnout caps a trend that has been building over the past two decades.  During the previous three presidential elections, the total number of voters as a percentage of total eligible voters increased significantly (see Table 1).  (This year's final numbers were not in at our press time.)  Electoral votes show a landslide in 1996, while the Republican wins in 2000 and 2004 were very close.  

 *in millions. Data: www.archives.gov Source: CMC EResearch

Stock Market Performance During Election Years

Here are some interesting observations on market performance related to presidential election years.  Will all these trends continue to bear out?

When the economy has been in a recession or entering one during a presidential election—1920, 1932, 1944, and 1960—the S&P 500 has fallen 3% on average.  The incumbent party lost three of those four elections.

Measured by the returns of the Dow Jones Industrial Average, there have been 15 bear markets since 1958, and four started in a presidential election year—1960, 1968, 1976, and 2000 (although only 2000 ended in the red).

Over half of election years since 1952 have posted a negative return for the first four months, but all except 2000 recovered before year's end.  See Table 2 below, for term- year returns and Table 3 below, for market troughs by presidential term.

Pharmaceuticals and biotech have consistently underperformed in election years, but they tend to bounce back strongly in the first year of the new presidential term.

Defense stocks have outperformed the market by +19% over the last eight election years—irrespective of the party in power.

Data: Standard & Poor's. S&P 500 Index returns with dividends reinvested, 1948-2007

Source: CMC EResearch 

Data: Closing price of S&P 500, Stock Trader's Almanac 2008 and Yahoo! Finance Source: CMC Research

Political Party And Market Performance

Perhaps surprisingly, records show that from 1926 to 2000, the broad Standard & Poor’s 500-Stock Index performed better under Democrats than Republicans, 15.24% vs. 10.78%.  When a Republican president held office, the value-weighted equity return delivered a nearly 2% premium over the Treasury bill (see Table 4).  When a Democrat held office, the premium was nearly 11%. 

Data: Journal of Finance, Center for Research in Security Prices; Source: CMC EResearch

These results were generated by higher real returns and lower interest rates under

Democratic administrations.  Business cycle fluctuations analyzed in a number of studies showed no correlation to the results, demonstrating statistically significant outperformance for the Democrats regardless of underlying economic conditions. 

Value-weighted portfolios posted a steady 10% premium in favor of the Democrats, while equal-weighted portfolios came in at around 20%.

Examination of business-cycle variables show that expected returns (those anticipated by the markets) were 1.8% higher under the Republican administrations, while unexpected returns were 10.8% higher when Democrats were in power, suggesting that stock market results may be driven by Democratic policies that surprise investors.  Interestingly, the results do not show up close to election dates, but rather grow over time during the president's term.

President Eisenhower (1953-1961) was the only Republican to hold office during a statistically significant period of market outperformance, while President Roosevelt

(1937-1941) was the only Democrat to preside over a massive underperformance. 

Furthermore, an equal number of presidents from each party (two and two) held office when the numbers came in roughly at par with the benchmark index.