The markets are still a swing voter

DOES the stock market vote Republican or Democrat? The US presidential elections are now only two weeks away. And as with any major event, there is no shortage of people who think that it will have an effect on the markets one way or another – usually in line with their own political bent.

Traditionally, the markets were seen as registered Republicans. The GOP’s deregulation, pro-business and anti-tax rhetoric seemed much more in line with the interests of the financial world than the Democrat’s tax-and-spend policies. But statistics show that the markets are soft Democrat voters. Recent research by Pedro Santa-Clara and Rossen Valkanov has studied average excess return of a basket of indices above the return of the three-month Treasury note. When a Republican President held office, the value-weighted return delivered nearly a 2 per cent premium over the three-month Treasury. When a Democrat held office, the premium was nearly 11 per cent.

And when it comes to election-cycle theory, this research from Santa-Clara and Valkanov is only the tip of the iceberg. For example, statistically, when a Republican is running against an incumbent Democrat, stocks have a tendency to show positive returns regardless of who wins the election. But the problem with all of these stats is that they are derived from a very small sample. Over the last century, we have only seen 27 US presidential elections and since 1948 there have only been 15 different terms.

Election statistics may be interesting, but basing your trading strategies on them is risky. However, that is not to say that you should discount the elections from your market view. “With the polls being so close, there could be some volatility injected into the markets in the run up and possibly following the elections, purely due to the build up of uncertainty surrounding the outcome,” says Angus Campbell, head of market analysis for Capital Spreads.

The markets response to either candidate will be heavily influenced by the victors response to the so-called “fiscal cliff” at the end of 2012, when the Budget Control Act of 2011 is scheduled to come into effect. The act kicks in at midnight on 31 December. It brings in a raft of measures, including the end of the Bush-era tax cuts, the end of some business tax breaks, the end of last year’s temporary payroll tax cuts and the beginning of the taxes to finance President Obama’s health care laws. The fear is that the US Treasury will struggle to handle the 3.5 per cent drag on GDP that the perfect storm of measures is predicted to create.

Nancy Curtin, chief investment officer at Close Brothers, is firmly in the Romney camp over the response to America’s fiscal conundrum: “A Romney win would be a clear boon for markets: immediate tax cuts for corporates, no increase in capital gain and estate taxes (likely to create year end selling distortions) and a supply-side business friendly approach.” Curtin adds: “The world needs confidence and Romney is best able to deliver that immediate sugar high to investors.”

Whether you agree with Curtin or not, markets can still be seen as a floating voter, looking for clear communication from either candidate and a credible plan to get America back to work.