The Impact of the Obama and Trump Presidential Election Cycles on the S&P500.

• Author: Morales, Lucia

Introduction

In 1970, Niederhoffer et al. (1970) developed an early study assessing stock market fluctuations during the days and weeks surrounding the United States elections. They found evidence of a strong connection between presidential elections and stock market performance. At the time, stock markets were reacting positively to the win of the Republican candidate whereas a negative performance was associated with a Democrat victory in the short-run. Since then and until today, the study of potential associations between stock markets and politics has attracted the attention of the academic community as well as of market practitioners (Goodell et al., 2020; Li et al., 2020; Shaikh, 2020; Sy and Zaman, 2020; Chang et al., 2020; Bekaert et al., 2019; Ahdi et al., 2015; Bialkowski, 2008). To name but a few, Pantzalis et al. (2000) investigated the behaviour of stock exchanges around election times across 33 countries, finding that, on average, stock markets reacted positively and significantly within the two weeks before the elections. Further empirical evidence is given by Bialkowski et al. (2008) who studied the interplay between finance and politics on stock market volatility around national presidential election times and who suggested that politics do play a substantial and significant role for investors that seek compensation whenever they take on additional risk. The most notable observation was that investors are not perfectly diversified internationally, given that their assets are invested in a country with upcoming elections. As such, investors appear to be compensated for bearing political risk during times of elections. Wong and McAleer (2009) stated that a significant number of voters tend to be euphoric in the year following an election, as they expect that the promises made by the presidential candidate while running for office would be implemented once elected president. This has been a main guiding finding in the political science literature on voters' satisfaction. On this direction and when looking into full electoral cycle, Nemcok and Wass (2020) demonstrated that for most of the European countries, satisfaction levels do not differ between winners and losers as the gap between these two groups remained stable during the electoral cycle. Thus, when returning to the American context, it is of interest to consider a comparative political study developed by Stiers et al. (2019) that focused on the Netherlands, a research approach that could be replicated in the context of the US. The research findings offered some insights on how voters levels of satisfaction during the first days of the incumbent government appeared to be helpful when trying to explain voters trends during a new election, "rather than the myopic voter, evidence is found of the abiding voter--steady at her or his post, evaluating government performance over a long length of time" (p. 646).

Overall, it should be noted that, since 1900, five U.S. presidents, namely Calvin Coolidge, Franklin D. Roosevelt, Dwight Eisenhower, Bill Clinton and Barack H. Obama have witnessed stocks markets indices rise by more than 50% during their time in office. Research findings suggest that abnormal returns might be connected to periods of elections associated with higher degrees of uncertainty, whereas the incumbent's defeat is expected. Figure 1 below visualises the performance of the S&P500 in the context of the US different administrations since 1965. The chart shows how the US presidents confronting times of economic uncertainty appear to have faced significant levels of market volatility during their terms.

For example, in the 1970s, the S&P500 was disturbed by the oil crises, and the US experienced a double-dip or W-shaped recession. An early and shortlived recessionary period emerged in the early 1980s triggered by a dramatic rise in interest rates to fight high inflation levels. This short period of economic slowdown was followed by a longer period of tighter monetary policy that sought to control rampant inflation levels due to the 1970s energy crisis, and that was later enhanced by the regime change in Iran and its spillover effects on the oil markets. Another early recessionary period was experienced in the early 1990s that once more saw a combination of the rise of interest rates and of oil prices due to the Gulf war. After this rather short recessionary episode, the US economy experienced a long period of economic growth that was sporadically disturbed in the early 2000s by the dot-com bubble and by the 9/11 terrorist attacks. The decades preceding the Great Recession already visible in 2007 were the longest period of quasi-uninterrupted growth in the US (Field, 2007). It took some time for the S&P500 to regain its growth patterns severely impacted by the Great Recession's outburst with its epicentre in the US subprime mortgage market. The subprime mortgage crisis led to the collapse of the US housing bubble with global spillover effects that developed into the global economic and financial crisis. The US economy showed signs of recovery in late 2009, and the S&P500 returned to a positive trend that was interrupted by the outbreak and diffusion of the COVID-19 disease. At that stage, the recovery of the S&P500 had been initiated by the Bush administrations economic stimulus programme early in 2008 aimed at preventing a looming recession. But, after this period of US stock exchange growth, the 2020 global health crisis struck the world, leading the S&P500 to experience a sharp and temporary decline followed by a rapid and robust recovery under President Trump's single term in office as illustrated in figure 2.

During the period 2000-2008, the S&P500 performance was overshadowed by the dot-com bubble and, above all, by the global economic and financial crisis respectively with the later event leading to a drop in stock market returns by around 37%. The disruption by the global economic and financial crisis is a factor that needs to be considered carefully when examining the S&P500 behaviour during the time of the Obama administrations. On average, the S&P500 registered annualised returns of around 16.25% during the Obama administrations with a better performance of 17.49% registered during Bill Clinton's two terms. In the same vein, the disruption caused by the 2020 health crisis needs to be accounted for when examining the stock market performance under President Trump. As Baker et al. (2020) show on their in-depth study of stock market reaction to COVID-19, there are no precedents of crisis events and of pandemics that affected the US stock market in such an exceptional manner as the global health crisis. The markets annual performance during the Obama and Trump administrations showed that even though the markets performed quite well during Trump's term, they did not out-perform the patterns showed during the Obama's second term.

The relationship between the US presidential election cycle and the S&P500 index is examined in this paper, focusing on the Obama and Trump election cycles. The paper research aims are two-fold: first, a critical analysis of the extant literature examining the impact of presidential cycles on stock markets is offered. Secondly, the paper provides an empirical analysis examining the effects of the US presidential cycles during the Obama administration two terms in office and Trump's administration single term. The study is supported by daily data spanning from January 20, 2009 to November 16, 2020, to capture both presidents' terms in office supported by well-established econometric modelling and the support from the LASSO algorithm to enhance the model specification. An important aspect to consider is that Obama hold two terms in office. At the same time, Trump administration was limited to a single term, and as such, comparisons between the two administrations are limited and need to account for this fact. This paper addresses a research gap as there is no evidence of research studies examining the impact of economic and political uncertainty in the context of the Obama and Trump administrations and even though a comparative analysis is limited, the study helped unveil distinctive aspects with the Democrat and Republican presidential cycles. The paper follows the ensuing structure: the first section discusses the relationship between presidential elections and stock market performance. Section 2 presents the data and the methodology used in the paper. Section 3 discusses the findings whereas some conclusions will be suggested in a final section.

Historical Insights on Presidential Elections and Stock Markets Performance

The influence of politics on the economy is a research topic that has generated vast interest among economists and political scientists. Many studies have been devoted to examining the relationship between the political party in office and the stock market performance in a given country and throughout a comparative perspective. Niederhoffer et al. (1970) provided one of the first studies analysing the Dow Jones Industrial Average (DJIA) changes before and after a US election. After examining 18 presidential cycles from 1900 to 1968, they stated that stock market performance does not exhibit a systematic difference between Republican and Democrat terms. Nordhaus (1975) is considered as being a pioneer of the Political Business Cycle (PBC) as he examined how unemployment and inflation rates affected investment activities during times of elections (Colon-de-Armas et al., 2017). Based on the views reflected in the Philipps curve, Nordhaus (1975) defined the political business cycle as follows: "To combat inflation the incumbent party has to raise the unemployment rate straight after the election. While approaching the election, the incumbent party will diminish unemployment" (Nordhaus, 1975: 173). The first researchers that provided an institutional analysis of the voting...