Anita Babic
Professor Ryan Jones
ENG 102: 12204
12 August 2024
Research Paper Rough Draft
The stock market and economy are two of the most complex functioning systems in the world. There are countless factors that influence actions within economies and the stock market. From government policies to individual consumer trends, it is difficult to predict outcomes. The United States is a democracy which encounters federal congressional elections every two years and presidential elections every four years. The election cycles form a hostile political climate as Democrats and Republicans fight to hold power in Congress and the executive branch. The infighting and uncertainty of these elections is representative in the stock market. With respect to market risk and returns, they can indicate whether the public is supportive and trusting of the current political power. The United States stock market is affected differently depending upon presidential elections and the political party in power of the federal government, in addition to world events that affect global markets regardless of implemented policies.
The two dominating political parties have used the stock market to justify their political actions and highlight their success. How much of their rhetoric is true and what are the real, factual results shown in the stock market? The other and more interesting side of that question: how does the United States' political climate impact the stock market? The interplay between political developments and market performance is evident in how market risk and returns can reflect public confidence in the current administration. The stock market's reactions can vary significantly depending on the outcomes of presidential elections and the political party in power, as well as on global events that impact international markets. This underscores the intricate relationship between domestic political conditions and global economic trends, illustrating the challenges in economic forecasting and investment analysis.
Historically there has been a question of if a political party in power of the United States government impacts the stock market even with different economic conditions at the time the party assumes power. It has been claimed that Democratic Party has historically had higher market returns when in power than the Republican Party. Noah Endicott, a student at Southeastern University - Lakeland, conducted a study detailing how politics and world events have affected the United States stock market. The study found that both parties historically have shown good returns but a Democratic president has never finished their term in office with a negative return, and data suggests at least a small positive return for stock market consumers when investing during a Democratic presidency (Endicott). Other expert financial analysts from the CFA Institute Enterprising Investor found, "9% higher stock market gains for large stocks in Democratic administrations since 1928. However, Santa-Clara and Valkanov did not correct for swings in market volatility or examine periods before the Depression, when market volatility was lower" (Foster). There are major factors that influence stock market trends and behaviors, and the experts that provided this analysis have taken those into account. Democrats have been proven to yield higher returns, but there are other angles that also need to be examined.
Other studies claim that there is instead a stronger correlation between political parties and risk in the stock market, rather than political party and returns. The aspect of investment pricing is also a factor that should be examined. A bear market is determined by a prolonged drop in investment prices and a major downturn in financial markets. When Republicans control both the White House and Congress, it can substantially shorten the length of a bear market in the post-election period (Wang). Additionally, it has been determined that stock returns are "higher on average during Democratic administrations, consistent with the finding in Hensel and Ziemba (1995). Moreover, jump risk increases for large stocks during Democratic regimes, but is similar for small stocks across partisan regimes" (Endicott). Risk for large stocks has been historically higher for Democratic presidents, while their returns have also been larger. The balance between risk and return in the context of the stock market creates a question of which party is truly better for stock market consumers? The answer to this question can be divided between two categories: small stocks and large stocks. Small stock investors are typically ordinary American people, while large stock investors are normally big business and large corporate figures in the world. The determinants of which political party is better for the stock market rests on the question of what demographic the stock market should benefit.
Furthermore, the recent United States presidential elections in 2016 and 2024 have significantly impacted the stock market and showcased how different political ideologies and policy promises alter the minds of stock market consumers. The 2016 United States presidential election represents one of the largest surprises in politics; the election of Donald Trump and his administration's following political events significantly impacted stock market indexes. On election day, "Companies that paid relatively high tax rates saw relatively strong gains that day, indicating investor expectations of a tax cut" and "Companies facing stiff import competition also did well, as would be expected if Donald Trump's America First rhetoric were to translate into more restrictive policies towards imports" (Firman and Zitzewitz). The market responded to the election of Donald Trump by reflecting his rhetoric and promised policies. The Trump administration was also known for erratic staff turnover and corruption. They had many high profile actions and events which inspired the opposite of confidence and trust for the American people in his administration. Following the firing of FBI Director James Comey, there was a sharp decline in the index in the month after but the index gained ground again when Comey's testimony to Congress failed to provide more damaging evidence (Firman and Zitzewitz). The stock market reflected the tough political climate of the time and confirmed that political unrest spooks consumers and influences market transactions.
The 2024 election is another example of how the political climate and unrest affects the stock market. Featuring President Joe Biden and former President Donald Trump, the 2024 presidential election showcases market impacts that arise from political elections. Studies conducted on the market indicated that a "higher probability of Trump's election is associated with a lower equity market volatility and higher stock prices, which is coherent with the more pro-market attitude of the Republican candidate" (Albori et al.). They also indicated a shock which leads to lower oil prices and a higher expected supply of fossil fuels, reasoning that this shock is reflective of the Trump administration's negligible interest in environmental matters and his distrust of renewable energy (Albori et al.). It responded to the probability of a second Trump presidency and showcased his positive attitude toward domestic industries. The stock market model was projected to communicate the interests of the Trump administration and it can be used to help consumers predict future market trends.
The financial crisis of 2008 is another example of a time when the stock market crashed and this event provided its own set of challenges. However, the difference between the 2008 market failure and the COVID-19 devastation is magnitude. The 2008 financial crisis demonstrated the governments' ability to intervene and positively steer the stock market back on track. Conducted by a University of South Carolina undergraduate student, Samruddhi Somani analyzed the policies implemented to deter the damage. Regarding effective policies, "the only policy action that significantly affects index futures prices is the creation or the adjustment of swaps...the most effective way to intervene in the economy such that the stock market reacts positively is to change expectations" (Somani). Backed by her research, she claims that "Decreasing the federal funds rate appears to be the most practical way for the government to change expectations and thereby increase stock prices" (Somani). Consumers of the stock market acknowledge that there is difficulty in steering it as so many factors play into market transactions and events. The 2008 crash was extraordinarily devastating, but it underscores and represents where and how governments can successfully step in to save the stock market.
The COVID-19 global pandemic highlights how the stock market responds to a serious global event and the corresponding political actions are not able to save the market. The pandemic resulted in extreme stock market failure around the world regardless of policies implemented by various governments. Studies referenced by Noah Endicott revealed that 52 out of 77 countries' stock markets showed irregular negative returns, and the whole world markets crashed once the pandemic was announced. In addition, analysts compared the bond market and stock market reactions to the pandemic. They found, "The return and volatility of the stock and bond market in most sample countries or regions have had a very obvious negative impact since entering this year's epidemic period, but the return volatility of the stock market is more severe than that of the bond market" (Liu et. al). The COVID-19 pandemic destroyed the world economy and devastated the stock market. Governments around the world are still looking to recover from economic losses resulting from the pandemic.
Although fiscal and monetary policies were implemented as a means to lessen the effects of the COVID-19 pandemic on the stock market, they proved to be less effective than governments hoped they would be. These policies aimed to force a quicker recovery and make up for the losses during the pandemic. Feng Lui with his team of researchers determined that "Monetary policy brought more volatility to the stock market than fiscal policy, that was, the effect of fiscal policy on market volatility was 4.16% and monetary policy effect was 4.7%...The stock market, fiscal policy implementation brought better returns, the effect of fiscal policy was -10.87% and the effect of monetary policy was -19.72%" (Liu et al.). Furthermore, fourteen countries have still not recovered from the negative returns after the announcement of the pandemic, including four developed countries' stock market, five developing countries, and five undeveloped countries (Endicott). Regardless of political climate or policy, markets around the world were destroyed by the pandemic and highlighted the instability behind countless economies. There is no one clear answer to remedy this ongoing situation, but it proves that politics and policy cannot always save market failures.
The intricate relationship between the stock market and politics underscores the profound impact that political dynamics can have on financial markets. The stock market is influenced by political events, election cycles, rhetoric, and policy promises. It demonstrates the sentiment of the American people and illustrates the trust they have in the current and future political party and president. Political uncertainty plays a major role in market behavior and can signal future growth or failure in specific industries. Generated by frequent election cycles and partisan conflicts, market behavior is constantly changing, influencing investor sentiment and market volatility. Additionally, the reactions of the stock market to political developments often reflect broader economic expectations and uncertainties.
Understanding this interplay is crucial for investors, policymakers, economists, and market consumers because it highlights the importance of considering political factors when analyzing market trends and economic forecasts. Stakeholders can better navigate financial markets by recognizing the ways which political shifts and government actions impact market performance. As the global political environment continues to evolve, ongoing research and analysis will be essential in unraveling the connections between politics and the stock market. By understanding this interplay, there is more informed decision-making and strategic planning in investment and policy contexts.
Works Cited
Albori, Marco, et al. "US Election Risks and the Impact of Trump's Reelection Odds on Financial Markets." Center for Economic and Policy Research, 16 July 2024, cepr.org/ voxeu/columns/us-election-risks-and-impact-trumps-re-election-odds-financial-markets.
Endicott, Noah. "The Stock Market and Politics: An Analysis of Stock Market Reactions to Political Decisions and World Events." Southeastern University - Lakeland, 2022, firescholars.seu.edu/cgi/viewcontent.cgi?article=1159&context=honors.
Firman, Raymond, and Eric Zitzewitz. "What Does the Stock Market Tell us About Politics?" Econofact, 14 May 2018, econofact.org/what-does-the-stock-market-tell-us-about- politics#:~:text=Government%20policies%20create%20winners%20and,beliefs%20about%20its%20future%20profitability.
Foster, Lauren. "Does the US Presidential Election Impact the Stock Market?" CFA Institute Enterprising Investor, 9 Sept. 2015, blogs.cfainstitute.org/investor/2012/08/31/weekend- reading-does-the-us-presidential-election-affect-the-stock-market/.
Liu, Feng, et al. "Effect of Economic Policies on the Stock and Bond Market Under the Impact of Covid-19." Journal of Safety Science and Resilience, U.S. National Library of Medicine, 30 Oct. 2021, ncbi.nlm.nih.gov/pmc/articles/PMC8556069/.
Somani, Samruddhi. "The Effects of Government Policies on the Stock Market." University of South Carolina, 2015, sc.edu/about/offices_and_divisions/research/news_and_pubs/ caravel/archive/2015/2015-caravel-stock-market.php.
Wang, Fan. "Essays on the Impact of Presidential Elections on the U.S. Stock Market." University of Kansas, 30 Aug. 2019, kuscholarworks.ku.edu/bitstream/handle/1808/ 31517/Wang_ku_0099D_16814_DATA_1.pdf?sequence=1&isAllowed=y.
