Political Cycles and the Stock Market
We find that the average excess return in the stock market is higher under Democratic than Republican presidents– a diﬀerence of 9 percent per year for the value-weighted portfolio and 16 percent for the equal-weighted portfolio. The diﬀerence is economically and statistically significant, does not seem to be due to small sample biases, and is robust in diﬀerent subsamples. There is a remarkable monotonicity in the diﬀerence of returns for size-decile portfolios, from 7 percent for large firms to about 22 percent for small firms. Presidential partisan cycles have a heterogeneous impact on industry returns: the tobacco, telecom, and chemical industries have performed better under Republican presidents, whereas the real estate, construction, and services industries have fared significantly better under Democrats. We test three plausible explanations for these findings. First, the relation might be due to political variables proxying for business-cycle factors. Second, the relation might be attributed to unexpected returns around elections, when information is revealed, rather than to expected returns varying with the political cycle. Lastly, diﬀerences in stock market riskiness across presidential regimes could account for the diﬀerence in average returns. We reject all three hypotheses. As it stands, the diﬀerence in excess returns during Republican and Democratic presidencies is a puzzle that cannot easily be explained. However, the cross-sectional evidence from size-sorted and industry portfolios suggests that the party in the presidency may aﬀect the stock market through diﬀerences in fiscal and regulatory policies.