Conventional wisdom has it that Republicans are friendlier to Wall Street than Democrats.  One might assume, therefore, that when a Republican is in the White House, stock market performance would be better than during a Democratic administration.  An interesting 2003 academic research paper by Pedro Santa-Clara and Rossen Valkanov at UCLA’s Anderson School of Business discovered exactly the opposite.  Titled The Presidential Puzzle: Political Cycles and the Stock Market, the study found that stock market performance was on average 9% higher in real terms under Democratic presidents than under Republicans, and that these results were economically and statistically significant.

Using data going back to 1927, the authors found that the average excess return of a value-weighted stock index over the three-month Treasury bill rate had been about 2% under Republican and 11% under Democrats.  That 9% divergence breaks down into higher real market returns (above 5%) and lower real interest rates (about 4%).  They also found that the divergence in returns decreased with market capitalization.  It was only 7% for the largest firms but as high as 22% for the smallest.  There was also no evidence of any significant stock market gains or losses around the election dates.  The difference in excess returns tended to build up homogeneously throughout each presidential term.  Despite this huge Democratic stock market outperformance, however, Santa-Clara and Valkanov were not able to reach any conclusions about the causes.

More recently, Bob Drummond at Bloomberg News reported that the Democratic edge still holds.  He looked at S&P 500 gains during Republican vs. Democratic administrations since John F. Kennedy and found that “the Democratic S&P fund logged a 992 percent gain, versus 109 percent growth for the opposition party, even though Democrats occupied the White House for 23 years over the period, compared with 28 years of Republican presidential leadership.”

As to why, Sam Stovall, chief investment strategist at S&P Equity Research in New York, notes that some of the difference may stem from the fact that nine of eleven recessions that began since 1945 – and seven of eight since Kennedy ran for president in 1960 – started with Republicans in the Oval Office.   He also speculates that Democratic administrations also may be more likely to spend money on government programs that stimulate the economy.

Does this mean you should sell all your stocks if Romney is elected in November?  Stock market anomalies such as this do not make very effective investment strategies in my opinion.  Sticking to proven diversification strategies and making adjustments based on asset class valuations is far more likely to result in well-managed investment performance.  But what do you think?

Here’s the link to The Presidential Puzzle: Political Cycles and the Stock Market: http://docentes.fe.unl.pt/~psc/Politics.pdf

Here’s the link to the Drummond article: http://www.bloomberg.com/news/2012-02-22/stocks-return-more-with-dem-in-white-house-bgov-barometer.html