Tuesday, November 07, 2006

A Word About Donkeys, Elephants, Bulls and Bears

It's Tuesday, November 7th and the midterm elections are today which means that -- after several weeks of posturing and mutual recrimination --we will once again learn who will be representing us in government on a state and federal level. It also means that pundits for both parties have been working overtime on the talkshow circuit to make the case that their party is the best for investors.

To spare you the trouble of sitting through another political talkshow snipe-fest, I will briefly recap every talkshow exchange on this subject.

Moderator: Have investors been better off under Republicans or Democrats?

Republican Pundit: Our supply side ecomonic policies, stimulus packages and capital gains tax reductions have spurred superior growth that has most benefitted investors. Everybody knows this. And any period of subpar performance during a Republican presidency is due either to the repurcussions of an irresponsible liberal predecessor or to anamolous events completely beyond one's ability to predict or control.

Moderator: Hmmm. Interesting argument. Democratic pundit, how do you respond?

Democatic Pundit: Scoreboard!!!

In fact, the Democrats can claim scoreboard on this one. Dr. Jeremy Siegel has compiled some data on the average annual return of stocks under the last 11 presidents. The average return during a Democratic presidency is 15.23% vs. 9.53% for their Republican counterparts.

Here's how they stack up. Democrats are in Blue. Republicans are in Red.

President %Ret

Clinton: 19
Truman: 18.26
Ford: 17.21
Reagan: 15.18
Kennedy: 15.15
Ike: 14.96
Bush I: 14.44
Carter: 11.04
LBJ: 10.39
GW Bush: (0.92)
Nixon: (1.32)

(Note the data compiled reflect only up to February of 2006, so GW Bush's position would not change but the numbers on his watch would improve.)

But what does it all mean? Rather than providing a basis for prediction, all the chatter surrounding the subject of party affiliation may be most instructive as a lesson in the Representative Bias; a cognitive heuristic in which we tend to make judgments made based on how representative a given individual case appears to be, independent of other information about its actual likelihood.

In other words, we tend latch on to some information because it is easy for us to mentally classify while we ignore other information that may be more important, but isn't as handy. Drowning deaths are at their highest when grass is at its longest. Why is this? Because its during summer. The representative bias would have legislatures pass a law requiring weekly lawn mowing to increase safety.

We could choose to slice market data in countless ways, but we don't. What about who controls the other 2 branches of government? What about accounting for the Treasury Secretary or Fed Chairman? Just how important is the president to stock market returns anyway? Jimmy Carter is widely considered to have been one the weakest presidents in terms of economic policies in history. He still can boast 11% returns in his tenure.

Intellingent people can debate the merits of the Democratic vs. Republican fiscal policy. We here at Marketpsych don't take sides. However, when one considers the multitude and complexity of factors that move markets, (e.g., world trade, geo-political instablitliy, interest rates, natural disasters, commodity prices, the weather see link, etc.) we suggest that the party affiliation of the president (which doesn't necessarily account for policy decisions anyway) is a rather arbitrary label on which to base prediction.

Still should vote though.

1 comment:

Richard said...

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. The difference in returns through the political cycle is therefore a puzzle.


The Presidential Puzzle: Political Cycles and the Stock Market

University of California, Los Angeles - Finance Area; National Bureau of Economic Research (NBER)
University of California, Los Angeles - Finance Area
Journal of Finance, Vol. 58, pp. 1841-1872, October 2003