John Nofsinger examines the historic relationship between who in office and how the stock market does. Contrary to previous papers that used data that went back to only to 1927, Nofsinger reports that for a longer time period (back to 1828!) "The full time-series history reveals that stock market returns are not different between the two political parties"
Talk about a timely paper! It is nearly impossible to watch TV without election coverage inundating you. Moreover many of you undoubtedly have been asked what does one party's candidate mean for the stock market. This speculation has been a hot topic on TV and in the popular press. For example: Business Week, Smart Money, The Baltimore Sun, CNN, and many others have done stories on what the presidential election means for the Stock Market.
The problem with many of these articles is that they are based more on opinion and short data sets (for example, the stock market was up when Clinton was president, therefore Democrats must be good for the stock market).
In academia the tie between presidential election and stock returns has also been looked at. While the data sets are bigger (generally from 1927 on), and the analysis more thorough, the findings are still quite mixed. For instance Santa-Clara and Valkanov report in a recent Journal of Finance article that the stock market does better when a Democrat is president than when a Republican is in office. This can be contrasted with Riley and Luksetich (1980) who find that the market rises on the news of a Republican victory.
Nofsinger examines this apparent contradiction by going back further in time. Using monthly stock data from 1802 (WOW--how cool is that?!! Jefferson was president!), and election data from 1828, he finds no apparent difference in stock market returns based on which party "owns" the White House.
In addition to this important finding Nofsinger proposes an important relationship that may exist. This "social mood theory suggests that the mood of the nation is reflected in the...stock market." (Is anyone else thinking of Charoenrook's Does Sentiment Matter?)
In Nofsinger's own words:
"As an alternative to the political policy theory, I propose that the performance of the stock market is a predictor of who will be elected president. When social mood is optimistic, the stock market is high and voters are content to reelect the incumbents. When social mood is pessimistic, the market is low and voters vote out the incumbent party. Therefore, this social mood theory suggests that stock market performance influences who wins the presidency...."
And later in the paper:
"In the social mood theory, I propose that people suffer from a misattribution bias (see Hirshleifer (2001)) when voting for president. That is, they miss attribute the source of their mood to the incumbent presidential party. They credit the incumbent party for their positive or optimistic mood and blame incumbents for a negative or pessimistic mood."
As such, "stock market returns are more likely to predict presidential elections than elections are to predict the stock market." (p. 1) Specifically, Nofsinger finds that the the return in the 3 years (36 months) prior to the election is a good predictor of whether the incumbent or challenger will win the election.
All in all a fascinating article and one that will definitely makes great conversation at many conference "sessions." (You can also read 'session' as party, social etc. ;) )
BTW the paper is also full of some cool facts such as equity ownership was less than 2% at turn of 20th century as opposed to about 50% now.
So read it! :)