Votes and profits: a complicated relationship

By Stephen Evans BBC North America business correspondent

Do stock market traders understand how politics affect the markets?

It's obvious, really: a Republican president is better for your wallet than a Democrat president.

The party of the Right, we all know, sympathises more with enterprise. So the stock market will perform better when the Left is in the wilderness and the Right is in the Oval Office.

After all, businessmen know what's best for business and businessmen back Republicans.

Except that it's not actually true.

Risk premium

Many business leaders do support the Republicans, but many don't. (Warren Buffett, perhaps the shrewdest investor on the planet, is backing John Kerry.)

But it's not true in a much more fundamental way, too.

The few rigorous academic studies that have been done on how Wall Street performs under different administrations show two important findings: in the past, stock prices have been doing better under the Democrats than under the Republicans, and real interest rates have been lower.

Two professors of finance at the University of California, Pedro Santa-Clara and Rossen Valkanov, concluded that from 1927 to 1999 annual stock market returns were about 11% higher than safe three-month Treasury bills during Democrat administrations compared with 2% under Republican administrations.

Making money on Wall Street may not depend on politics.

And however you measure it, the result is the same: stocks on a broad measure, like the S&P500 stock market index, do better under Democrats than under Republicans, according to the professors' study, "The Presidential Puzzle: Political Cycles and the Stock Market", published in the Journal of Finance.

So, why is this so? Is it because Democrats are worse at running the economy so stock prices rise to offset the added risk?

Not so, according to the authors: "There is no riskiness of the stock market across presidencies that could justify a risk premium."

Puzzle

Conversely, might it be that Democrats are just better at running the economy than Republicans?

Jittery traders, uncertain about which way to go

The authors discount this, too. Their study looks at the return from stocks compared with a benchmark - the safe Treasury bill.

If the economy was doing better or worse under one regime than another, the difference between stock price and the Treasury bill price should not be that different unless something else was going on. In theory, both should move up or down with the economy.

Which means we (and the authors) are left with a puzzle.

No guarantee

One explanation might be that investors in stocks have poor expectations of Democratic administrations and heightened expectations of Republican administrations.

Investors are then pleasantly surprised by the policies of Democrats and disappointed by those of Republican presidencies so stock prices gradually rise under the former and gradually fall under the later.

Democrats are painted over-bleakly on the economy and Republicans over-rosily - so the reality pushes prices up for the former and down for the latter.

Maybe. It remains a puzzle.

But what is certain is that a vote for Kerry or a vote for Bush does not guarantee a worse or better performance for your portfolio. It doesn't work as simply as the tabloids might have you believe.