The Canadian Press - ONLINE EDITION
(Special) - Financial markets and investors around the world will be focusing their attention on the results of the upcoming presidential election in the United States next month. Whether voters decide to re-elect Barak Obama or make a change in leadership in favour of Republican Mitt Romney could well determine how financial markets perform in the months and years ahead.
Jack Ablin, chief investment officer of BMO Harris Bank, says Obama's campaign has argued that government has largely been responsible for business success because of its investments in roads, bridges and infrastructure. Romney on the other hand has argued that the country is overburdened by government mandates and taxation.
"The nature of the presidential election hinges on how to best guide the economy: free market capitalism or a mixed economy emphasizing government investment," says Ablin. "It is a mandate on capitalism and the size of government. A Romney victory has the potential to take Washington's philosophy in a different direction and any sense that Romney could take the White House would be greeted with a strong positive reaction in the equity market."
History seems to indicate that U.S. presidential elections can impact the movement and performance of financial markets.
One of the most prominent theories on the subject is the presidential election cycle theory.
According to Investopedia, this theory states that U.S. stock markets are weakest in the year following the election of a new U.S. president. After the first year markets improve until the cycle begins again with the next presidential election.
While the theory was relatively reliable in the early- to mid-1900s, data from the latter half of the century has disproved it.
In 1937, Franklin D. Roosevelt's first year, the market was down by 27.3%. The Truman and Eisenhower eras also started off with a down year in the stock market.
However, the start of more recent presidencies showed a different pattern. In George H.W. Bush's first year, the market was up 25.2%, and the start of both of Bill Clinton's terms showed strong market performance - up by 19.9% and 35.9% respectively, Investopedia says.
Going back to 1928 and incorporating 21 elections, RBC Capital Markets concluded in a recent report that the final 12 months leading up to the election is the worst performing year for the TSX while the first 12 months following an election is the weakest for the S&P 500.
The report found that the third year of a presidential term is the best for North American equity markets with median returns of 14.7 per cent for the TSX and 21.2 per cent for the S&P. The weakest performing year for the TSX with a median return of 5.4 per cent is the fourth year of a presidential term compared to the first year for the S&P 500 with a 1.6 per cent median return.
One of the study's interesting findings is that markets do react differently to Democrat and Republican victories.
For a four-year term., the median annual compound growth rates for the TSX and S&P 500 for a Democratic-term president are 13.8 per cent and 10.0 per cent respectively compared to 0.4 per cent and three per cent for a Republican term.
"Contrary to popular opinion, equity markets yield better returns in the years following the election of a Democratic president," the report says. "Tracking performance on a year-by-year basis over election cycles we find that a Republican win tends to be associated with soft share price performance in all the years with the exception of year three (while) performance following a Democratic win has been more consistently positive in each of the four years after an election."
"The bottom line - the TSX and S&P 500 historically produced better returns when a Democratic president is elected," the report concludes.
The RBC report further found that the materials and technology sectors on both the TSX and S&P tend to perform more poorly in the three months leading up to the election while energy, financials and technology on the TSX and health care, financials, consumer staples and consumer discretionary stocks on the S&P 500 tend to perform better in the first six to nine months following the election.
"Probably the two most sensitive sectors to this election are health care and financials - health care because of the sweeping legislation that President Obama ushered in in his first term and financials based on the ongoing regulatory environment for the banks," Ablin says.
No matter who wins the election, financial markets and investors likely will have something to say about the result.
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.
Copyright 2012 Talbot Boggs
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