Why Stocks Biden Will (Probably) Soar under a Biden Presidency
By: Ben Le Fort
Tags: Politics, Money, Investing, Economics, Election 2020

Why Stocks Biden Will (Probably) Soar under a Biden Presidency

But not for the reason you think

Image by heblo from Pixabay

If you were to ask most people under which political party, Democrat or Republican, the stock market performed better under; most people would probably say Republicans.

After all, Republican's policies often focus on lower corporate taxes and fewer regulations.

If like me, you assumed this to be true, then you might be surprised to learn that the stock market has performed better when the Democrats are in power, and it’s not even close.

This article will explain why the stock market has greater returns under a Democratic presidency and why Democratic policies are not the cause of those higher stock market returns.

Stock market returns are dramatically higher when a Democrat is occupying the oval office

For anyone worried about how their investment portfolios might perform under a Biden administration, let me put your mind at ease. There is no reason to believe the stock market will tank if Biden wins the election, and if history continues to repeat itself, investors could see a windfall coming their way.

In their 2017 paper, “Political Cycles and Stock Returns,” authors Lubos Pastor and Pietro Veronesi found that the average stock market returns under a Democratic presidency were nearly 11% higher per year than Republican presidencies.

That is a jaw-dropping number when you consider why investors put their money into stocks in the first place; because they expect to earn a higher return investing in risky assets like stocks than they do risk-free assets like T-Bills.

If you expected to get the same return from T-Bills as you did from stocks, no one would invest in stocks. The difference in expected return in stocks and T-Bills is referred to as the “risk premium.” You’ve probably heard the term “no risk, no reward,” the risk premium is the reward for taking the risk.

The entire risk premium for stocks has been captured when Democrats are in power

Now that we understand what the risk premium is, we can understand the extreme gap in stock market returns under Democratic presidents compared to Republican presidents.

The findings by Pastor and Veronesi suggest that the entire risk premium for U.S stocks is captured when a Democratic president is in office.

Put another way; when Republican presidents are in office, the stock market has roughly the same return as a three-month U.S Treasury Bill.

That does not mean Democratic policies have been better for the stock market

A natural conclusion that many people would jump to is that the stock market's outperformance during Democratic presidencies must be due to their policies.

However, Pastor and Veronesi push back on this idea.

It might be tempting to offer explanations based on different economic policies of the two parties. Perhaps Democratic policies are good for the stock market, or Republican policies are bad. However, such explanations would require a large amount of market irrationality. Investors would have to repeatedly misprice stocks by failing to anticipate such policy effects. -Lubos Pastor and Pietro Veronesi

To put what they are saying in more relatable terms, for the outperformance of the stock market under Democratic presidents to be explained by Democratic policies would require investors to constantly underestimate the impact of those policies on the stock market and economy for the better part of a century.

Currently, there is no statistical evidence that is the case.

So, the question remains why does the stock market perform so much better when a Democratic president is in power?

It has everything to do with when Democrats get elected.

Democrats get elected during times of economic uncertainty

Pastor and Veronesi offer a more rational explanation of why the stock market performs better under Democrats; Democratic presidents get elected during periods of economic uncertainty when voters and investors feel risk-averse.

As I’ve written in the past, the future expected returns of stocks are highest after a stock market crash, which also happens to be when Democrats get elected.

We can verify this fact by simply reviewing the economic circumstances in which most Democratic presidents have been elected in the past century.

In 1932, Franklin Roosevelt Herbert won a landslide victory in the presidential election over Herbert Hoover, which took place during The Great Depression.

In 1960, John F. Kennedy narrowly defeated Richard Nixon to become president during the recession, which began in April of that year.

In 1976 Jimmy Carter defeated Gerald Ford shortly after the painful recession that lasted from 1973–1975, where unemployment and inflation were high.

In 1992, Bill Clinton defeated George H. W. Bush following the recession of 1990–1991.

In 2008, Barack Obama defeated John McCain during the early days of the financial crisis of 2008–2009, which came to be known as “The Great Recession.”

While I am not making any predictions about the current U.S election, at the time I write this, Joe Biden leads Donald Trump by nearly 11 points in national polling.

If Joe Biden goes on to become president, it would be another clear case of Democrats getting elected to the oval office during times of extreme economic uncertainty with the unemployment rate in the U.S hovering around 8% in September 2020.

Here is the rational explanation for stock market outperformance under Democratic presidents. Democrats get elected during times of great uncertainty and oftentimes following an economic decline and stock market crashes. When the period of uncertainty passes, the stock market usually experiences a rebound, and prices soar.

Don’t use political cycles to try and time the market

While the statistical relationship between presidential elections and stock market performance is fascinating, it should not be used to try and time the market.

The work by Pastor and Veronesi offers a compelling explanation for what has happened in the past but does not hold predictive power for what will happen in the future.

There is no guarantee that the stock market will soar if Joe Biden gets elected president. In part because, unlike when Barack Obama was elected, the stock market has already recovered to its pre-recession levels. The 2020 stock market crashes was one of the fastest drops and recoveries in history.

One thing certain; we are currently living through a period of extreme uncertainty, and when that uncertainty clears, we will all be better off.