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What is the impact of the US presidential elections on the economy and the stock market?
With the US presidential election on the razor's edge and less than a week away, the financial markets are holding their breath.
There are plenty of reasons to be nervous. The two sides presented radically different visions for America's economic future, with major implications for the rest of the world.
All this comes against a backdrop of latent tensions with China and a persistent crisis in the Middle East. The price of gold, a common way investors hedge against uncertainty, has reached record highs.
Many have speculated about what might happen to the stock market and the economy, both in the United States and here in Australia.
Of course, it depends on more than just who sits in the Oval Office. However, history still reveals an interesting and perhaps surprising story.
Read more: From mass deportations to huge tariff hikes, here's what Trump's economic agenda would do to the US and Australia
Elephants, donkeys, bulls and bears
In the United States, both sides of the political divide are subject to simplistic stereotypes.
Democrats are often seen as the party of proactive government spending, favoring policies to redistribute wealth through taxation. Republicans, on the other hand, have a reputation as the party of small, business-friendly government, favoring more passive policies with lower tax rates.
So, you might be surprised to learn that if we step back and look at much of the last century, the U.S. economy and its stock markets actually performed better under Democratic presidencies, on two key measures.
Stock investors seek a return above the risk-free rate. Detail by Seth Wenig/AP
Research by Lubos Pastor and Pietro Veronesi of the University of Chicago examined the period between 1927 and 2015.
They found that average gross domestic product (GDP) growth was 4.86% under Democratic presidents. Under Republican presidencies, it averaged 1.7%.
Over the same period, the equity risk premium on U.S. stock markets was also 10.9% higher under Democratic presidents than under Republican presidents. In the years 1999 to 2015, it was even higher under Democratic presidents, 17.4%.
This is the excess rate of return that can be earned by investing in stocks above the risk-free rate (such as the interest rate on a savings account).
Why is it worth looking at the risk premium rather than total stock market returns? Because it allows you to separate the effect of interest rates.
The return on assets like stocks is made up of the banks' risk-free rate plus this risk premium. Risk-free rates are largely determined by central banks, which in most countries are independent of government.
What could be causing this effect?
The question of whether this performance reflects luck or good policies is much more difficult to answer. If the effect resulted from superior policy decisions, it would imply that voters have repeatedly failed to reward good government.
Pastor and Veronesi argue something different: When the economy is weak and stock prices are low, voters are more risk averse. This may lead them to prefer Democrats' wealth redistribution policies.
The last three transitions from Republican to Democratic presidencies support this theory. Bill Clinton was elected shortly after the 1990-91 recession, Barack Obama at the height of the global financial crisis, and Joe Biden during the pandemic.
As the economy recovers from a crisis, stock prices often rise. Pastor and Veronesis's thesis suggests that the election and good performance of Democratic presidents comes down to the timing of voters' increased risk aversion.
Barack Obama was elected president of the United States in the midst of the global financial crisis in 2008. Jae C. Hong/AP Highly interconnected economies
Historically, monthly stock returns in Australia and the United States have been highly correlated. My calculations show that this is even more true in election years.
It is well known that correlation says nothing about causation, but that when we see a change in one, we usually see a similar change in the other. This means that some of the effects we described earlier can also be felt here (and around the world).
Expanding their long-term analysis internationally, Pastor and Veronesi found that the average risk premium for Australian stocks was also 11.3% higher under Democratic presidencies in the United States!
Similar, higher yields were also seen in the UK, at 7.3%. And they were even higher in Canada, France and Germany, at around 13%.
Two factors can explain why what is happening in the United States is of such magnitude. Stocks in these markets are held globally. The US presidential elections could reflect the global cycle of risk aversion, which in turn affects local stock markets.
These economies and financial markets are also highly integrated with the United States in areas such as trade, making their economic cycles highly correlated.
The United States is highly integrated with other major Western economies in areas such as trade. Heidi Besen/Shutterstock A stock market boom?
Will a Democratic victory in November lead to a stock market boom? This is unlikely, for two reasons.
First, a Democratic victory would be a continuation, not a transition, of a Republican president. This would not represent policy changes favored by the most risk-averse voters.
Second, it would be a Democratic victory in a booming economy. The American economy has been doing well since the end of the pandemic.
It created 254,000 jobs in September, the strongest job growth in six months. It also grew at an annualized rate of 3% in the second quarter of 2024, above its average of less than 2% over the past decade.
Other research also suggests some important caveats. On average, the short-term market reaction to an election favors neither Democrats nor Republicans.
However, a surprise victory by a Republican, contrary to market predictions, is associated with 2-3% higher returns on election days.
One possible reason for this is that, unlike voters, stock fund managers are more likely to lean Republican. A surprise victory by their preferred candidate can send stock prices soaring when the winner is declared.
Read more: New book reveals much of Trump's success is based on myth that he's a self-made billionaire
Sources 2/ https://theconversation.com/how-do-us-presidential-elections-affect-the-economy-and-the-stock-market-241805 The mention sources can contact us to remove/changing this article |
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