Market volatility around U.S. election seen as short-term

By Doug Watt | October 27, 2004 | Last updated on October 27, 2004
3 min read

(October 27, 2004) The stock markets could be jumpy in the days around next week’s tight race for U.S. president, but long term it likely won’t make much difference, says the author of a new study on elections and market trends.

“Markets rally as soon as it becomes apparent who is going to be elected,” says Robert Johnson, executive vice-president at the CFA Institute. “This one is certainly up in the air.”

“The worst thing that could happen is that we have an election that isn’t decided or that there is litigation,” said Johnson, who spoke to following a presentation this morning to a group of financial analysts in Calgary.

If that happens, Johnson expects further downward pressure on the markets. “I’ve said that if either John Kerry or George Bush would have been thrust into the forefront as the obvious frontrunner, we would have seen a market rally.”

Johnson says that although elections are important, in the long run, which party runs the U.S. doesn’t really matter, at least in terms of market performance.

Johnson’s study, conducted by the CFA Institute and researchers at Northern Illinois University, looks at the historical relationship between market returns and the outcome of presidential elections, with data going as far back as 1926.

It concludes that the monetary policy of the U.S. Federal Reserve is far more important than the election with regard to market returns, and that next week’s vote, whatever the outcome, should be treated as a “minor distraction.”

“What we’re suggesting is there is no systematic relationship between whether a Democrat or a Republican is in the White House and market returns,” Johnson says.

If Democrat John Kerry follows through on his pledge to roll back the Bush tax cuts and increase the tax rate on dividends, that’s negative for the markets, adds Johnson. “But it’s short-term because you have to counterbalance that against how it will affect the deficit in the long run.”

The study claims to be the first to consider the political landscape and monetary conditions jointly in an examination of security patterns; not only stock returns, but also equity indexes, fixed income indexes and the rate of inflation.

Equity returns may be marginally higher during Democratic administrations, the study suggests; however, fixed-income returns, both long- and short-term, have experienced superior performance under Republican regimes.

“After controlling for shifts in the political landscape, we find strong evidence that shifts in Fed monetary policy have a significant relationship with security returns, a pattern that has been particularly prominent over the past three decades,” the study says.

From an economic perspective, the most important person in Washington is not the president, it’s the chairman of the U.S. Federal Reserve, Johnson says. “And by most accounts, Alan Greenspan gets extremely high marks in his management of monetary policy.”

“Our study shows that equity and debt markets perform well when the Fed is pursuing an expansionary policy, when rates are falling. Markets don’t perform well when rates are rising. So, investors fare well when the Fed pursues an expansive monetary policy.”

The study also debunks the myth that political gridlock — when the party in Congress differs from the party in the White House — is beneficial to market performance.

The study looked at periods of gridlock and non-gridlock over a 74-year period. During gridlock, the S&P 500 averaged a 14% return, compared to 13% when there was no gridlock, Johnson notes. And small stocks actually performed better during periods when the same party controlled both Congress and the White House.

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Doug Watt