In a recently completed study, the authors of several widely-recognized articles on politics and security returns challenge conventional wisdom regarding the association between security returns and political election results. The authors conduct a comprehensive examination by analyzing several political and monetary policy variables and conclude that some previous findings regarding political associations and asset returns are likely spurious.
In their study, “What to Expect When You’re Electing," co-authors Scott B. Beyer, Ph.D., CFA, associate professor at the University of Wisconsin Oshkosh College of Business; Luis Garcia-Feijoo, Ph.D., CFA, assistant professor at Florida Atlantic University College of Business; Gerald R. Jensen, Ph.D., CFA, professor of finance at Northern Illinois University College of Business; and Robert R. Johnson, Ph.D., CFA, professor of finance at Creighton University College of Business show that investors should focus less attention on the party of the president and instead more closely monitor Fed actions.
Furthermore, it appears that political harmony should be welcomed by equity investors, but not debt investors. Finally, regardless of the political outcome, if the past serves as a guide, investors may have to wait until year three of the next presidential term to enjoy the fruits of the current political season.
The study considers security returns from 1965 through 2008. The authors examine several dimensions of the political landscape ─ the party of the president, the presence or absence of political gridlock (when the Senate, Congress and Oval Office are not all controlled by the same political party), and the presidential term effect (the phenomenon that returns are highest in the third year of a presidential term) ─ in conjunction with Fed monetary policy in examining long-term security returns.
The joint analysis allows the authors to isolate the relationship that a particular political factor has with security returns by controlling for other relevant factors. Since security returns are likely influenced by both fiscal and monetary policy, failure to consider the variables within a joint analysis increases the likelihood of producing misleading and biased findings.
- The key empirical findings reported in the study are consistent with the following: Equity investors, especially those that target small-cap stocks, would be wise to monitor Fed policy actions, while paying limited attention to the party of the president. Investors should be particularly wary of a shift to a restrictive Fed monetary policy.
- Contrary to the conventional view, equity investors should welcome political harmony; however, debt investors should prefer continued political gridlock.
- Fed policy shifts warrant consideration as potential signals of coming inflationary pressures. A shift to a restrictive policy stance should alert investors to higher future inflation and support a re-allocation to securities that offer more inflation protection (e.g., commodities and TIPS).
- Regardless of the political outcome in November, it appears that equity investors will have to wait until the third year of the next presidential term before reaping the benefits of the election season.
“The return relationships that many financial commentators attribute to the party of the President and political gridlock appear to be spurious,” said Johnson. “While the evidence is consistent with the view that effective portfolio strategies require investors to carefully monitor both monetary and fiscal policy developments, there is no support for the widely-held view that gridlock is beneficial for equity markets or for the claim that party of the President systematically influences security returns. On the other hand, the persistence of a third year effect in the Presidential term appears robust after controlling for other influences.”
Robert R. Johnson can be reached at 434-249-2805 to comment on the research and its implications for the upcoming election.