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Andrew Allentuck

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Moving markets

Andrew Allentuck

Presidential election cycles leave their footprints on capital markets. Data collected by scholars who study presidents and markets have found that stocks do best when Democrats are in power and that bonds do best when Republicans in power.

The reasons for the wide divergence of returns are elusive, but the numbers are striking. According to a widely quoted study by Professors Pedro Santa-Clara and Rossen Valkanov, both of the University of California at Los Angeles, stock market returns are on average about 5 per cent higher when the White House is commanded by a Democrat than by a Republican. Their study, in the prestigious Journal of Finance in October, 2004, showed that in the 72 year period between 1927 and 1999, American stocks returned 11 per cent more a year on average than 90 day U.S. Treasury bills, a referent chosen as a zero risk baseline. Meanwhile, under Republicans, stocks gained only 2 per cent over 90 day T-bills in the period.

Markets also give different marks to valuation. The Santa-Clara/Rossen study

showed that portfolios heavily weighted with low multiple value stocks returned 9 per cent more under Democrats than under Republicans in the 72 year period. Portfolios equally weighted with growth and value stocks gained 16 per cent more under Democrats than under Republicans.

The pattern appears to be consistent for Republican George W. Bush and his Democratic predecessor, Bill Clinton. Under Clinton, who held office from 1993 to 2001, stocks produced an average annual compound gain of 17.4 per cent per year.

Under the incumbent, who has held office since January, 2001, the Dow Jones Industrial Average ended 2000 at 11,497 and, at time of writing in Feb., 2008, hovers at

12,738. That 10.7 per cent total gain translates into an average annual compound rate of growth of 1 per cent a year.

The question of why markets like Democrats, the party of the people according to popular lore, more than Republicans, widely seen as the party of business, begs for an answer. Forbes magazine suggested in a March 1, 2004 article that inflation tends to be higher under Democrats. Inflation causes asset prices to rise. Then it is up to Republicans to put on the brakes when they come to power. Data show that 30 per cent of months under Republican administrations have been spent in recession while, under Democrats, recession has been under way in just 10 per cent of months. Whether the U.S. is in recession in 2008 is not certain, but if it is, the pattern would appear to be holding.

The expansion/contraction phenomenon appears to account for the performance of bonds under Democrats and Republicans. Since 1929, returns on intermediate term and long-term bonds have been 5 percentage points a year higher under Republicans than under Democrats. In fact, with inflation removed from measurements, the average return on bonds during Democratic administrations has been approximately zero.

Stock market data suggest that investors are followers of trends rather than initiators of them. For example, the Dow Jones Industrial Average rose 48.2 per cent in 1928, the year that Republican Herbert Hoover was elected. In the following year, the Great Depression began, wiping out approximately 90% of the value of the stocks which survived and could be measured by time a recovery began in the Roosevelt administration.

Why presidents can move markets is unclear. American monetary policy is made by the Federal Reserve Board, which is politically independent of the White House. One would have to think that fiscal policy, which is manufactured by the White House and confirmed by the Congress, would be responsible for the performance of U.S. capital markets. Yet on macroeconomic questions, Democrats and Republicans are not very far apart. Writing in the New Yorker in November, 2006, columnist James Surowecki noted that Democrats tend to block tax cuts for upper income taxpayers, but the would-be populists have not done much to rill tax rates back to where they were before the

Repubicans got into office. "Both [parties] pay lip service to balanced budgets, even though Democrats appear more committed to them in practice."

The data appear to show consistent market behaviour when sorted by

the party coming into power. According to the Stock Trader's Almanac, an annual publication, the final two years of presidential administrations are far better than the first two for stock investors. The Almanac shows a total net market gain of 745.9 per cent for the last two years of 44 administrations since 1833 to the end of the first administration of George W. Bush compared to a 227.0 per cent total gain in the first two years of those administrations. But don't bet on 2008 coming out a winner. Stocks closed Dec. 2007 about where they began in January. So far this year, things look a lot worse.

Andrew Allentuck writes about investments for The Globe and Mail, and reviews books on finance for globefund.com and globeinvestor.com. He is also the author of several books.

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