Too many investors are prone to fall prey to their ideological biases. If you’re a strong Republican, you see the world as being better when Republicans are in charge, and vice versa. Folks also think their “team” has been and will be better for stocks. And you can slice and dice the data various ways to support either Democrats or Republicans being better. But inherently, neither party is better or worse. There are timing differences. Thinking otherwise is just an ideological bias at work—a form of cognitive error—and in investing, biases are your natural enemy.
Yes, in long-term history, Democratic presidents have had slightly higher returns on average than Republicans. But think the way a statistician would think. They would routinely throw out the couple of highest and lowest returns by both parties as likely quirky weird phenomena that don’t mean anything in and of themselves—and then consider what happens with the rest of all the years. Is there a difference? With statistical consistency? When you do that, throwing out those few outlier quirky returns, Republican and Democratic presidents on average look almost identical (see Bunk 40).
Plus, some of those years when a president did very well or badly, his party controlled Congress and other years the opposition controlled Congress. When you start adjusting returns tied to congressional power versus presidential power things get murkier still.
But by now you know the forces behind what I call the presidential term anomaly—fourth years (which are election years) have much better returns than first years (a new president’s inaugural year)—depending on how much investors fear poli-tics will redistribute away their money or rights.

Party Can Matter—At Certain Times

That said, the president’s party can matter at certain times. One of those times is in election years; another is inaugural years, particularly when parties flip-flop. Election years when presidential power changes D to R, stocks average 13.2 percent (see Table 41.1)—nicely above average. When congressional power changes too—both swinging from blue to red (albeit wholesale party power changes happen less frequently)—returns average a huge 25.5 percent—way above average! That’s where the real action is. Why?
The investor class is about two-to-one more Republican than Democrat. And Republican poli-tics are usually seen as being pro-market and pro-business. They say and promise pro-market things as they seek election, and most investors and markets feel reassured by that and do relatively better than they would otherwise—helped by the reassurance. When Republicans get elected, markets tend to do above average in that election year.
Conversely, Democrats are seen as big promoters of social policy—they promise fairness and bigger government to oversee all that fairness. Often, those promises are seen as anti-business and anti-free market—that scares most investors and markets, causing them to do worse than they would otherwise. Election years when presidential power changes R to D, markets fall an average 2.8 percent—way below average—like 2008! When Congress changes power R to D, too, stocks fall an average 8.9 percent. Ugly!
Table 41.1 Party Changes and S&P 500 Performance—A Perverse Inverse
Source: Global Financial Data, Inc., S&P 500 total return from 12/31/1925 to 12/31/2009.
Election YearInauguration Year
Presidency changed from Republican to Democrat-2.8%21.8%
Presidency changed from Democrat to Republican13.2%-6.6%
Both presidency and Congress changed from Republican to Democrat-8.9%52.9%
Both presidency and Congress changed from Democrat to Republican25.5%-3.0%

A Perverse Inverse

The perverse part comes in the inauguration year—year 1 of a president’s term—when all that changes again. A perverse inverse! Inauguration night, after having a few beverages of his choice (I say “his” because they’ve all been male—so far), the brand-new president immediately begins campaigning for re-election. Maybe there have been a few presidents who waited until the next morning—but I doubt it.
And new presidents know their power base has nowhere to go—they’re trapped for the next four years. There is no way conservative Republicans are going to suddenly turn on a Republican president in favor of Democrats any more than liberal Democrats will turn on a Democratic president in favor of Republicans.
So his sole concern in re-election is appealing to valuable independents and the more marginal members of the opposition party. Independents make or break a president. So the president talks to his base loyally but moderates what he actually does, whether he initially intended to do that or not. He backs away from some initiatives and tones down some others that he knows annoy the independents most. This is true for both parties. If he doesn’t moderate, he loses popularity fast.
So, in inaugural years, new Democratic and Republican presidents do less than folks hoped (or feared) during the election. The pro-market Republican turns out to be just a politician and not the pro-market champion that markets expected. They’re disappointed, so stocks average a loss of -6.6 percent in new Republican presidents’ first years. There hasn’t actually been a Republican president other than Bush-1, whose first term’s first year was positive in the history of the S&P 500. (Look back at Bunk 40.)
But when a Democrat wins power from a Republican, the market is expecting an advocate for French-style socialism. Yikes! But the Democrat is just a politician too. He turns on his captive power base and moderates—doing less than markets feared in the election year. Markets are positively surprised and increasingly relieved—rising a huge average 21.8 percent in new Democrats’ inaugural years.
This is exactly what happened with President Obama. Markets were scared to death of him as he took office and then became slowly less afraid, leading to a great inaugural year—US stocks up 26.5 percent1 (on the heels of a horrid election year—US stocks down -37 percent).2 Republicans continue to hate Obama as I write, but generally acknowledge he has done less than he pledged to do and less than they originally feared.
In fact, first years of Democrats’ first terms are nearly always positive—save Jimmy Carter in 1977 when stocks fell -7.2 percent (see Table 41.2). Perhaps he didn’t moderate enough. Some say he was a brilliant man who was a slow learner. And he was a one-term president! Overwhelmingly, despite first years having the worst average returns of any in overall presidents’ terms, Democrats’ first inaugural years have been just fine market-wise.
Political biases are fine. Most folks have them. Personally, I find politicians of both parties reprehensible, though I find normal citizens who self-identify as either Republican or Democrat perfectly fine. It’s like being a fan of a professional sports team. You like your team, hate the opponents. It gives you a sense of community. But political biases are dangerous when investing—blinding you to fundamental forces behind stocks.
There is a time when Republican politics helps markets and others when it hurts markets. Ditto for Democratic party politics. Knowing the difference in terms of how that affects sentiment and demand for stocks and the timing thereof is good. But if you get bullish or bearish just because the party you identify with won or lost, you’re reacting with no more real fundamentals, relative to the supply and demand for securities, than if you reacted based off your favorite sports team winning or losing. It’s bunk!
Table 41.2 First Years of Democrats’ Terms—Almost Consistently Positive
Source: Global Financial Data, Inc., S&P 500 total return.
First YearS&P 500 Return
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