August 2008

Democrat or Republican: What will it mean for your portfolio?

The upcoming US elections will be closely watched around the world. But how will the markets react?

The 2008 election is shaping up to be one of the more fascinating of the past 50 years. The post-George W. Bush era could see major changes in policy, from the role of the United States in Iraq to changes in taxes, environmental and health programs. However, trying to predict the market reaction to the US election outcome is difficult.

Old adages need not apply

The long-held belief has been that the markets tend to prefer Republican presidents who are reputed to be more pro-business – less in favour of regulation and more in favour of tax cuts. But this perception doesn’t stand up to scrutiny: the largest tax cuts ever – relative to the size of the economy at the time – were under Democrat President John F. Kennedy. Later, Republican Richard Nixon would bring in wage and price controls, a significant restriction on the free market aimed at slowing inflation.

According to the 2005 Stock Trader’s Almanac, the markets actually fared better under Democratic presidents than under Republican leadership. Between 1901 and 2004, the Dow Jones index grew by 383.7% during the 56 years of Republican leadership, or 6.9% a year. During the 48 years when a Democrat held the top office, the markets grew by 639.6%, or an average of 13.3% a year.

How did the market behave?
Dow Jones index       
Republican years   
Number of years
1901-1912 12 48.3%
1921-1932 12 -24.5%
1953-1960 8 121.2%
1969-1976 8 2.1%
1981-1992 12 247.0%
2001-2004 4 -10.4%
56 years
Average annual return   6.9%
Democratic years    
1913-1920 8 29.2%
1933-1952 20 318.4%
1961-1968 8 58.0%
1977-1980 4 -3.0%
1993-2000 8 236.7%
48 years
Average annual return   13.3%

Source: Stock Trader’s Almanac, 2005

However, analysts point out the seemingly higher gains under the Democrats tend to be offset by higher inflation. Also, major world events, such as the Great Depression or World War II, significantly affected the markets, but had little or nothing to do with who was in the White House at the time.

Term trends

This having been said, a closer look by researchers Wing-Keung Wong of the University of Singapore and Michael McAleer of the University of Western Australia showed a general trend that follows the course of each four-year presidential term: during the past 10 administrations, after an initial post-election rally, stocks tended to drop in the first year or year and a half, bottoming out in the second year of the term. They then began to rise again, peaking in the third or fourth year of the term.

In reality, what the markets seem to prefer is a government that maintains the status quo. A strong market will often emerge when the Republicans control one part of the government (such as the Presidency), and the Democrats control another (Congress or the Senate). In a system of checks and balances, this prevents either party from embarking on radical new policy initiatives that could have an impact on the ability to do business. The markets don’t like uncertainty.

A wind of change?

Yet, uncertainty will play an important role in the 2008 election: in tough economic times, voters often look for a new leader, but if the economy is strong, they tend to opt for the status quo. At the present time, the US economy is not doing at all well, and both presidential candidates are newcomers. A number of policies will be up for grabs, from NAFTA, the environment and health care to the war on terror, with no clear idea how these issues will unfold under the new leadership. Forget the status quo. There is definitely a wind of change. Just how much change American voters want remains to be seen.

Maintaining a steady course

Faced with such uncertainty, the markets are likely to continue being volatile for the time being – especially since several other factors are also holding their attention.

In such circumstances, an individual investor’s greatest asset is patience. Provided he is well aware of his tolerance for risk and is managing his portfolio with a long-term view, he will be able to keep a cool head, no matter which way the markets swing. That’s why everyone should take the time to have a discussion with his or her financial advisor to properly assess the situation and make his or her investor profile is still accurate.

In the end, one thing is certain: sooner or later, regardless of the elections, the markets will have to come back to their historical trends!