Wednesday, August 20, 2008

It's not just the economy in general that's far better under Democrats; the market's excess return has been higher by 9 percentage points

Jonathan Chait, in his current New Republic article, "Bush 36,000", notes "A recent Wall Street Journal editorial argued that, if the economy was sinking, it must be in part because markets fear the prospect of Barack Obama winning and raising taxes. (You thought Obama was up because the economy was bad? Turns out you had it backward.)"

As Chait has noted in his writings, historically, and for very good reason, the economy has been far better under Democratic administrations, and there are many sources reporting this, for example, two posts on the blog of Princeton Economist Paul Krugman, here and here.

What's much less known is that the stock market does tremendously better historically under the Democrats than under the Republicans. UCLA financial economists Pedro Santa-Clara and Rossen Valkanov report this in a 2003 paper published in arguably the most prestigious journal in academic finance, the Journal of Finance. The paper is "The Presidential Puzzle: Political Cycles and the Stock Market".

In the abstract they report just how amazingly better the market does under Democrats:
The excess return in the stock market is higher under Democratic than Republican presidencies: 9 percent for the value-weighted and 16 percent for the equal-weighted portfolio. The difference comes from higher real stock returns and lower real interest rates, is statistically significant, and is robust in subsamples. The difference in returns is not explained by business-cycle variables related to expected returns, and is not concentrated around election dates. There is no difference in the riskiness of the stock market across presidencies that could justify a risk premium.