Politics and religion: two touchy subjects to be avoided in social situations. The latter would seem to matter less these days, given the rise in the number of “nones” who don’t identify with any religious group. But with the former, the divide between parties has rarely been as wide, or as acrimonious.
It’s no wonder, then, that politics are becoming increasingly infused into investors’ view on the financial markets. Leon Cooperman has taken on Sen. Elizabeth Warren (D., Mass.), one of the leading contenders for the Democratic presidential nomination, who has championed a wealth tax—now with a top rate of 6%, instead of her originally proposed 2%—to finance her ambitious political agenda, notably Medicare for All.
Cooperman facetiously said a couple of months ago that “they won’t be able to open the stock market” if Warren is elected. He later amended that to a 25% drop for stocks should she win the White House a year from now. (This was before news late Thursday that former New York City Mayor Michael Bloomberg was mulling a run for the Democratic nomination.)
Other billionaire portfolio managers also have been opining on what next year’s elections might mean for stocks. Paul Tudor Jones last week told an investment conference that an internal poll at his firm predicted that a Warren presidency would send the
down to 2250, a 27% plunge from Thursday’s record close. The poll expected a drop in the S&P to 2700, a 12.5% decline, if either of two more moderate Democrats, former Vice President Joe Biden or South Bend, Ind., Mayor Pete Buttigieg, were to win in 2020. President Donald Trump’s reelection next year would send the S&P to 3600, a 19% gain, according to his firm’s poll.
Stock market performance under recent presidents has been decidedly mixed, however, with neither Republicans nor Democrats being able to claim an edge. Indeed, the best predictor of stock-market gains or losses during a president’s term has been how well—or poorly—his predecessor did.
According to CNN’s tracking through Oct. 31, the S&P 500 is up 34% since Trump’s inauguration on Jan. 20, 2017. It’s climbing at roughly the same pace as it did in George H.W. Bush’s single term, which saw the S&P rise 51%. The best, or luckiest, U.S. chief executive was Bill Clinton, whose two terms saw a 210% rise in the large-cap benchmark during the dot-com boom.
But George W. Bush saw a 40% drop, mainly from the Great Financial Crisis of 2007-08. Barack Obama entered office just before the beginning of the current record-long economic expansion; the S&P soared 182% during his two terms, coming off the vicious Bush bear market. That compared with the 118% rise during Ronald Reagan’s two terms, which kicked off the secular bull market that lasted through the end of the 20th century.
So neither elephants nor donkeys historically favor bulls or bears, which suggests that investors’ overall market outlook shouldn’t be influenced by their political preferences. That premise also applies to individual stock selection, academic research shows.
Mutual fund managers nevertheless tend to invest in companies whose executives share the same party affiliation, according to a recent paper by M. Babajide Wintoki, of the University of Kansas School of Business, and Yaoyi Xi, of the Fowler College of Business. Funds whose portfolios show more political bias tend to underperform and suffer more volatility risk than those with less, they found.
This partisan bias is stronger among less-experienced portfolio managers and for more “informationally opaque” companies, the academics contend. It’s also stronger when the president is from the fund managers’ own party, they concluded.
Why should supposedly rational, profit-maximizing investment pros let political preferences influence their choice of securities?
First, there’s the tendency to view those with the same social identity more favorably. Folks who share political ideologies might live near each other and move in the same social circles. That familiarity tends to influence them. This also results in social networks through which valuable information can be transmitted, the authors suggest.
In any case, Republican-leaning managers were found to have 8% more invested in GOP-leaning companies than Democratic-leaning managers. And Republican-leaning managers had about 3% less in Democratic-leaning companies than did Democratic-leaning fund managers. Overall, fund managers allocated about 43% of their assets to companies with executives with party affiliations similar to theirs and 33% to those with leaders with the opposite party affiliations. (The affiliations were gleaned from campaign donations.)
The underperformance owing to political bias was relatively small, Wintoki and Xi found. But the increase in volatility was statistically and economically significant. Ironically, investing with folks they were familiar with didn’t impart superior information to the fund chiefs. Indeed, some investors tended to hold on to losers longer when they felt simpatico with management.
Most interesting was the authors’ finding that political bias among fund managers decreased with age. Experience apparently taught them to separate their politics from their investments. Plenty of Republican investors have no problem owning
(ticker: BRK.A), famously headed by Warren Buffett, a prominent Democratic supporter.
If anything, suggestions that fund managers’ politics may influence their security selection might be another argument for index funds. Then again, the movement to portfolios based on noneconomic criteria, such as environmental, social, and governance considerations, also diverges from a focus on maximizing returns. But at least then, the investor—not the manager—is making the noneconomic choices.
Write to Randall W. Forsyth at firstname.lastname@example.org