Historically, US presidential election years have been good for the US equity market. According to Capital Economics, since 1897 the Dow Jones Industrial Average has risen by an average of 9.1% against an average increase of 7.2% in non-election years.
Similarly, the S&P 500 has increased by an average of 9.3% in election years, against 6.5% in non-election years. Note, however, that these are averages and thus smooth out what can be pretty large fluctuations in index performance over time.
That said, looking at the nine election years from 1970 reveals a very similar picture; the Dow Jones rising by 8.2% during election years and the S&P 500 by 10.8%. The most obvious explanation for this relatively strong showing is that election years have tended to be good years for the US economy. This does not look like being the case in 2008.
Does the ruling party ‘buy’ votes with loose fiscal policy?
US election years have, historically, been good years for the US equity market. To some extent this can be put down to the market’s view that either the incumbent president or, where the president has served two terms, the ruling Party has an incentive to “buy” votes by loosening fiscal policy in order to boost economic output growth.
This view is indeed supported by Gross Domestic Product data which reveals that US activity increased by an average of 8.1% in election years and by 7.1% in non-election years over the past century or so. However, a closer examination of fiscal policy heading into presidential elections does not support the assertion that it is loose fiscal policy alone which provides the boost on each occasion as cyclically adjusted federal deficits have actually fallen on average over the two years prior to an election.
Monetary policy data provides little support either. Since WW2 interest rates increased by an average of 0.3% points in election years while the benchmark 10 year Treasury bond yield increased by an average of 0.8% points.
There have, however, been very few occasions in which economic activity has actually contracted in election years and 2008 seems certain to be such a year given the collapse in the residential property market and inevitable impact on consumer confidence and spending patterns.
If US equity market performance is strong in election years on the basis of a strong underlying economic performance then investors can at least deduce that if the US equity market performs well in the run-up to November’s poll it is unlikely to have much to do with the economy this time round.
Perhaps the single biggest domestic achievement that President Bush can point to is the reduction in the Federal deficit to just 1.2% of GDP in fiscal 2007. However, in the wake of recent Congressional elections the president has been cast adrift by a legislature that is not now dominated by his own Party.
Whilst the reduction in the Federal deficit does provide some scope for fiscal loosening we believe it unlikely that an already log-jammed Congress has the time or appetite for tax cuts or spending hikes let alone the inclination to support policy which might improve the chances of a political rival.
Trends in equity market performance
According to Capital Economics it is possible to discern noticeable trends in equity market performance throughout election years themselves. On average US equity market performance tends to be pretty muted over the first half of an election year, the part of the year dominated by primaries intended to determine which candidates will run, with average gains from the S&P 500 Index below 3.0% by end-June.
Equity market performance generally improves through Q3 as the election campaign begins in earnest before stalling in the final six weeks before polling day, in early November, as uncertainty regarding the outcome (or extent of the majority) and consequent scope for policy action becomes the focus of attention. Equity market performance then tends to pick up markedly in the final seven weeks of the year as investors look forward to the new president’s policy initiatives.
Republican or Democrat: what’s best for equities?
Again, equity market data indicates that investors do tend to take strong positions based upon likely policy as advocated in Party manifestos. Generally speaking Republican administrations are regarded as being more equity market friendly than Democratic administrations, regardless of whether that view tends to be born out by ensuing reality.
Since 1897 the Dow Jones has increased by an average of 11.6% in years in which a Republican candidate has been successful and by just 5.5% in years when the Democratic candidate has won. On the basis that the Dow increased by 7.2% in non-election years over the past 110 years the highly generalised assumption is that US equities under-perform in years in which Democratic presidents are elected (the S&P 500 has increased by an average of 6.2% in Democratic election victory years against 6.5% in non-election years so the same rule, although less pronounced, holds true).
Note, however, that the opinion polls have been forecasting a Democratic victory in the 2008 election for some time. Equity market activity is being dominated by concerns regarding the uncertain long-term consequences of the credit crunch and its impact on the health of the real economy.
It is not clear to us that equity markets are, as yet, focusing on prospects for November 2008. At the time of writing outgoing president Bush continues to score poorly in public opinion polls while Hillary Clinton remains the favourite to secure both the democratic nomination and the presidency (despite Obama’s success in the Iowa caucuses).
The markets have yet to take a view regarding Mrs Clinton’s becoming the first woman president of the United States, preferring to focus upon president Bush’ shortcomings and the absence of clear front runner in the Republican nomination race.
While this is unquestionably a good thing, the comparative lack of clarity regarding the shape and hue of the US political map in eleven months time is undoubtedly causing some nervousness, particularly at a time in which the dollar is sliding on the foreign exchanges and the country’s reputation on the international stage is being called into question more strongly than at any time in the past thirty years.
Equity markets always have difficulty in ascribing appropriate probabilities to geo-political events but, as the recent assassination of Benazir Bhutto illustrates all too clearly, the vacuum created by US political uncertainty in an environment in which US influence is already on the wane, represents a substantial window for the country’s many and diverse opponents to exploit.
Thus the combination of a deteriorating macro economic backdrop, coupled with a much less settled geo-political environment than has been the case in the recent past (even counting two crises in Iraq) makes the outlook for US equity market performance more uncertain than ever.
Conclusion: an uncertain year ahead
The three conclusions we can draw from this analysis are that, firstly, US equity markets tend to perform relatively well in election years in which the Republican candidate wins. Secondly, that US equity market performance in election years tends to be more a function of the strength of economic fundamentals which are forecast to be weak over 2008 and thirdly, that the absence of clear front runner, coupled with waning US influence in the geo-political arena is providing the opportunity for the country’s opponents around the world to raise their profile and diplomatic tension which, if unchecked, could result in heightened risk and greater financial market volatility.
As a consequence we believe it hard to assert, with any degree of conviction, the view that just because 2008 is a presidential election year it will a good year for the US equity market.
By Jeremy Batstone-Carr, Director of Private Client Research at Charles Stanley