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Sunday, February 13, 2011

Impact of U.S. presidential elections on capital markets

Economic effect of elections
Executive agendas influence commerical regulation
It is a long held notion among investors and market speculators that election years tend to be good years for capital markets. This notion has been reinforced by observations of market performance over several decades and in some cases the last century or longer. However, for the market observations to proven as related to election years, different methods of accuracy testing can be applied to the observations including quantitative and statistical analysis.

While economics and market conditions cannot be measured with the same levels of empirical accuracy as some scientific research, the application of the aforementioned analytics help confirm or disconfirm the notion U.S. presidential elections do in fact impact capital markets.

Statistical positive election year capital market performance


Statistically, United States presidential election years have had a favorable correlation with capital market performance. According USA Today, a national U.S. newspaper, "Election years usually bring good news for stocks", the caveat being the usually it does implication. To illustrate, the newspaper took note of the annual performance of the Dow Jones industrial average, a composite stock index, from the years 1964-2000. Of the 10 election years since then only 1 yielded a negative return and the average of all the annual yields was 9.3%.

Similar reports and statistical measurements have been reported from other observers, one such example being the online magazine www.entrapreneur.com which looked at the S&P 500 returns since the 1928. According to that report, the S&P 500 has yielded 2.9% more in election years than non-election years and has averaged 12.6% returns in election years. Yet another examination by www.investmentu.com has put the chances of the "stock market" going higher at 75% since 1888.

So clearly there is a positive trend but does this actually mean US presidential elections actually influence capital markets? Not exactly, while there is clearly a correlation, correlations are not absolute statements and therefore the statement election years influence capital markets cannot definitively be made. Moreover, the capital markets are generally more inclined to "up" years than "down" years based on historical graphing. What can be said is there may be factors that influence the capital markets during election years that are not present or not as great as non-election years.

Market psychology during election years


Another factor that is considered to effect capital market performance is market psychology. Market psychology includes the sentiments and confidence levels of investors during specific time periods, and in this case that time period is the election year. Market psychology can be measured through surveys, online opinion polls, investment patterns, consumer behavior etc. These measurements can consequently be tested for validity using statistical analysis.

One type of statistical analysis is statistical hypothesis testing through comparing null and alternative hypotheses and then weighing statistical significance using p-values. This method takes to positions i.e. alternate and null-hypothesis such as election years are favorable to capital markets and election years are not favorable, and tests them for accuracy using market information. In other words, hypothesis testing is another way to measure the accuracy of the relationship between variables.

If a sample population is surveyed on their confidence level in the capital markets during election years, the results may demonstrate the alternative hypothesis of favorable confidence in the capital markets is present thus validating the market psychology theory behind the capital market performance given statistical significance i.e. accuracy as measure by P-values.

Administrative behavior and ensuing hypothetical influences on capital markets


Additional considerations one might give to the historical performance of capital markets during election years is the behavior of Government officials and Government agencies in election years. One such pattern of behavior includes the actions of the U.S. Federal Reserve Bank and the President, or the campaign platforms of Presidential candidates and legislation passed by the House of Representatives and the Senate.

While such election year behavior and administrative actions may be influential factors on capital market performance, drawing the conclusion such actions were intended and originated to influence the capital markets can be considered speculation as Governments have more than capital markets on their political agendas, i.e. the economy in general, base demographic support, legislative agendas, international politics etc.

The aforementioned campaign agendas of Presidential candidates may further inspire sectors of the capital markets that would be beneficiaries of the presidential platform. For example in 2008, the prices of gasoline and other fossil fuels reached new highs. The concern about the rising price of fuel to businesses and individuals alike may spur concern for a campaign platform position regarding energy conservation, improved efficiency standards, implementation of renewable energy etc.

Consequently, should the leading candidates have specific platform positions, this has the potential to, but not a guarantee to influence the movement of certain commodities, and/or ownership of securities within particular industries. These patterns are hypothetical as single isolated factors generally aren't the only factors that influence capital markets. In other words, the capital markets are quite large and influenced by more than just political agendas, however political agendas may be a contributing variable.

To recap, U.S. capital markets have been observed to outperform, if not yield positive returns during election years. This pattern has been quantitatively measured through graphical and historical metrics. The accuracy of these measurements can be tested for accuracy, in part, using statistical analysis. The statistical analysis measures accuracy of relationship and also tests hypotheses relating to the election year and capital market performance.

Since statistical analysis is not an absolute science, it is subject to error and this is vulnerable to speculative oversight. For this reason, the connection between election years and capital market performance, in addition to the variables that appear to influence this connection such as market psychology and government behavior tend to be somewhat speculative despite the evident historical patterns that are present in capital markets during election years.

Sources:

1. http://www.usatoday.com/money/markets/us/2004-01-26-martelection_x.htm
2. http://www.entrepreneur.com/magazine/entrepreneur/2007/october/184386.html
3. http://www.investmentu.com/IUEL/2003/20031218.html
4. http://www.usnews.com/usnews/biztech/articles/040119/19elect_2.htm

Image license: Scott Maxwell, CC BY-SA 2.0