For months, US stocks rose despite a deadly pandemic, the resulting economic devastation and the rise of a Democratic Party increasingly sympathetic to socialism, and led by Joe Biden. Then this month, with Biden maintaining a significant lead in the polls, stock prices finally stumbled.
If polls continue to point to a Biden victory in the 2020 presidential election, there will be a temptation to attribute any further tremors in stock prices to fear that a Biden administration would bring socialists into the White House. But the widespread idea that the market is reflexively ideological – pro-Republican and anti-Democrat – is not backed up by history.
My research, which reaches back to the 1860s, when the modern two-party system emerged, shows that the US stock market has no clear bias in favour of either major party, and that heightened market volatility in the run up to an election is perfectly normal.
The market is an economic barometer, not a political barometer. Its collective mind does follow presidential politics, but as just one of many factors that can influence the direction of the economy. Moreover, the leader it listens to most carefully is the head of the central bank – the Federal Reserve chairman – not the president.
The spectacle of stock prices soaring despite the rising death toll and continuing lockdowns may seem inexplicable, but the economic logic is simple. When states started imposing lockdowns in March, the market did suffer a drastic crash. Then the Fed and the Treasury rushed in with promises of trillions of dollars to help keep businesses afloat, and meet their payrolls, and the market recovered nearly as dramatically.
For the most part, stock prices have tracked – even anticipated – high frequency indicators such as traffic and credit card sales. These indicators have consistently surprised on the upside since April (albeit from very depressed levels), which explains why the market mood has been so much more optimistic than the public mood.
This month’s market tremors are best explained by growing concern about Congress’s failure to pass a new spending bill, delays in developing a vaccine against Covid-19, and the prospect of a contested election – not the prospect that Biden might win.
As for President Donald Trump’s repeated warnings that a Biden administration would bring economic disaster and a stock crash like 1929, there is no sign the market has been listening. Indeed, the market seems to like a fresh face in the White House.
The US market tends to respond eagerly after an incumbent loses, rising by 77% on average over the next four years, and to lose momentum the longer presidents hang on to office.
Since the 1860s, nine presidents have lasted at least five years and two terms in office. Eight of them saw higher market returns in their first term than in their second, often much higher. (Ronald Reagan was the exception.) First term returns averaged 83%; second term returns averaged just 28%.
This pattern is consistent with research on the “second-term curse”, which finds that underlying economic conditions tend to decline in a president’s second term. These conditions, including GDP growth and inflation, have tended – coincidentally – to be more favourable under Democratic presidents. Politicians can influence but can’t control the business cycle.
Economic factors, not partisan bias, are the best explanation for why markets have performed better under Democrats. Since 1869, the average market return over the course of a full presidential term was 68% under a Democratic president and 52% under a Republican.
Another clear pattern, also going back to the 19th century, is that markets grow more volatile in the three months before an election. Whatever upset the market this month, the volatility started right on time, historically speaking.
All of this data casts doubt on the widespread assumption that Wall Street is rooting for a Trump win. The related notion, that Wall Street is rooting against a Biden win because of his party’s leftward drift, also does not jibe with what people are saying on the street.
To sum up, the view of leading investors is that despite Biden’s campaign rhetoric, he would govern moderately, raising taxes and regulation while decreasing tensions over immigration, global trade and China. That mix would have some effect on which economic sectors do best during a Biden presidency, but little effect on the market’s overall direction.
More important, the market now cares less about who leads the free world than who leads the Fed, which has done more than anything else to inflate stock prices. Low interest rates make stocks look more attractive, so the Fed’s policies in recent years have been turbocharging stock prices. The US stock market is currently more expensive than at any time other than the dot-com bubble of 1999 to 2000, according to some measures.
What happens next in the market depends mainly on the direction of the economy and on interest rates. Over the coming months, if the economy keeps recovering but long-term rates start rising rapidly, the market could actually decline – a mirror image of this year’s market boom and economic bust.
Many traders, eager to see the market rally continue, are arguing hopefully that if Biden wins he will bring in even more dovish leadership at the Fed. That’s another reason Wall Street isn’t too worried about who wins this election, and more than anything just wants the race to be over.
DISCLAIMER : Views expressed above are the author’s own.