Election Matters: Short-Term Rally and (More) Uncertainty

Atypical Election

Finally, there is substantial research showing that the party that is in the White House makes a difference for stocks. Unfortunately, it's not a unanimous verdict.

According to widely cited calculations by Ned Davis Research, the stock market had a median gain of 8% in all election years since 1900, and 15% in years when Republican presidents were re-elected.

University of California at Los Angeles business school professors Pedro Santa-Clara and Rossen Valkanov tried to take out the effects of the business cycle and found that small growth firms do far better under Democrats than under Republicans, about a 22% better gain on average. The market as a whole did somewhat better, a 9% advantage, under Democrats and with less volatility.

For stocks, this year hasn't been typical of most election years in the past 50 years, again according to Ned Davis Research. The S&P 500 averaged a 12.8% gain in the past 12 election years. That's not as good as the 24% average gain in the year before a presidential election (like 2003 when the S&P gained 29%), but it exceeds the 7% gain in the first year after an 8% gain in the second year after.

As a caveat, some more academic research done by Dimensional Funds using criteria developed by Nobel Prize-winning economist Eugene Fama shows that the effects on the market may be pretty short-lived.

Looking at the monthly returns on stocks in excess of the return of risk-free Treasury bills, the study found statistically significant and above-average returns in the three months after a presidential election, but 12-month returns were similar to returns in nonelection years.

Not surprisingly, market returns ahead of elections can help predict the winner, according to the Dimensional study. In the 10 elections since 1928 when then incumbent was not re-elected, stocks underperformed T-bills by an average of 1.4% in October, compared with 2% outperformance in years when incumbents were re-elected and 0.1% outperformance for all Octobers (including election and nonelection years).

So far in October, the S&P 500 has lost 1.7% and three-month T-bills are yielding 1.83%.

To read RealMoney columnist Barry Ritholtz' take on the election, click here.

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