Time to explode some great election myths

By James Mackintosh

Markets thrive on myths, and the biggest one out there is that Democratic presidents are bad for US investors. It has become accepted Wall Street wisdom that if Republican Mitt Romney were to carry the White House on Tuesday, shareholders would be delighted. An instant bounce, the myth runs, would be followed by a stronger market thanks to Mr Romney’s business-friendly stance.

History does not bear out that judgment. Since Barack Obama took office in January 2009, US shares have returned 92 per cent, including dividends – equal to 19 per cent a year (see chart). Mr Obama also proved either unusually astute or lucky when he called the bottom of the market in early March 2009, only a week before it began the strongest recovery in a century.

So far, so much for chance. But look back to 1927 and the pattern is repeated time after time. On average the market gains far more under Democrats, even excluding the 1929 and 2008 crashes.

Of course, to have a Democrat in the White House does not guarantee fat gains. Franklin D. Roosevelt’s second term was miserable for investors – although he can hardly be blamed for a world war. Shares bucked the trend in Republican Dwight Eisenhower’s first term, too, with big gains.

Shares and Obama

Perhaps the next four years will again buck history, and conventional wisdom be borne out. There are several arguments why shares should do better with Mr Romney than Mr Obama.

First and most important is that a Republican White House will have more chance of convincing Congress to act quickly to avoid January’s automatic tax rises and spending cuts. The House is sure to be Republican, and while there is only a slim chance they will win the Senate too, Democrat senators would be demoralised if Mr Obama were to lose, and unlikely to risk being blamed for a recession by driving the US over the fiscal cliff.

Second, Mr Romney would be likely to ease rules on business, which investors seem to have concluded would mean a supply-side driven recovery. A survey of investors by Barclays found more than half thought shares would rise if Mr Romney were to win, against only a quarter for Mr Obama.

Thomas Lee at JPMorgan has a third argument. He expects shares to go up after the election whoever wins, since the uncertainty of the closest election since the 1930s will be resolved. But he forecasts bigger gains if Mr Romney wins; 60 days after five previous close elections equities were up an average of almost 6 per cent when the challenger won, and up less than 2 per cent when the incumbent won.

But this only works because the 2000 and 1948 races were excluded on the basis that both were in or just ahead of recessions.

Look at all 16 elections from Harry Truman’s 1948 win onwards and it is hard to see any special reaction. From election day to November’s end, markets rose half the time, with an even split between Democrat and Republican victors. While markets rose more under the full term of Democratic presidents, there was no difference immediately after the vote.

But surely a Republican supply-side reformer with the political clout to put in place a sensible plan to cut the deficit would be the best outcome for markets?

Perhaps not. US shares are back up to where they stood at the start of 2008 thanks to easy money from the Federal Reserve and government spending, much of which has found its way into corporate profits. Both would be under threat from Mr Romney, who wants someone more hawkish than Ben Bernanke running the Fed.

Many believe the Fed would not be changed before Mr Bernanke’s term ends in 2014, but if markets start to price in tighter monetary policy, it would mean higher bond yields and lower shares, all else being equal.

To cut government spending would hurt the economy. Mr Romney is no more likely to balance the budget than Mr Obama, but tax and spending cuts will force painful economic adjustments before any possible benefit is seen.

These effects could be offset by a stronger recovery. Corporate investment might be supported by removing “fiscal cliff” uncertainty. But this is merely the idea that Mr Romney will have better relations with Congress again, which is debatable, to say the least.

Historically, the biggest gap in equity performance between Democrat and Republican administrations has been in the outperformance of shares sensitive to public spending under Democrats, according to research by Frederico Belo of the University of Minnesota, Vito Gala of London Business School and Jun Li of the University of Texas. In the past, this has driven the whole market up more under Democrats. It could well do so again.

There is one final myth. Whisper it quietly, but perhaps the occupant of the White House is a little less important to asset prices than they, and the market, like to assume.

Copyright The Financial Times Limited 2012.


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