Is investing an art or a science? Those who insist it is the latter believe everything can be quantified and reduced to a model that increases one’s odds of success. Those who favour the former view think instinct and intuition will get you further than statistics.
In reality, however, there can be element of voodoo in even the most scientific-sounding explanations for the movement of stock prices. This usually happens when people, excited by finding patterns in the numbers, mistake correlation for causation.
The truth is that while different variables may have a statistical relationship (for example, ice cream consumption and the incidence of sunburn both rise on hot days), that doesn’t necessarily means that one is the cause of the other.
Back in 2012, the US financial academic Robert Novy-Marx released a study showing how one could use ostensibly high-minded statistical analysis to draw convincing links between how the market performs from year to year with a host of variables.
Among the factors said to predict market anomalies were cold weather in Manhattan, the El Nino phenomenon, the conjunction of the planets and even sunspots!
“The market performs significantly better when Mars and Saturn are opposed,” Professor Novy-Marx said, with tongue firmly in cheek. “Times when… their energies are polarised appear to be particularly propitious times to invest in the market.”
Another famous and frequently quoted correlation to the annual performance of the US S&P 500 stock index was the annual production of butter in Bangladesh. One paper cited a correlation of about 87% in the period between 1981 and 1993.
US Presidential elections
A far less exotic link, but timely right now given the looming US Presidential election, is the relationship between which political party occupies the White House and the performance of the stock market.
Of course, fans of either side will tend to proclaim their particular party is best for the market. Denizens of Wall Street, for instance, are known to have an ideological predilection for Republicans, given their favouring of tax cuts over redistribution.
Unfortunately for the rusted-on partisans, the evidence in how the market does depending on whether the blue team or the red team is in charge is mixed. If anything, in fact, the market has done better under the Democrats.
According to Professor Jeremy Siegel of the Wharton School, annualised US market returns from 1952 to mid-2020 were 10.6% under Democrat presidents and 4.8% under Republican presidents.
Going even further back, to 1926, the differences are even starker, according to this analysis by McLean Asset Management. With Republican presidents, the average return of the S&P 500 was 9.12%. With Democrats it was 14.94%.
Not that simple
But when you start looking at specific timeframes, a different picture emerges, with two Republican presidents — Calvin Coolidge and Gerald Ford — presiding over periods when annual stock returns were at their greatest.
This analysis is further muddied by whether the party that holds the presidency also controls the Congress. There, some of these ostensibly linear relationships break down and a lot of other equations start to kick in.
Ultimately, as McLean’s director of investment analysis Bob French points out, it is incredibly difficult to disentangle the US presidential election from all the other things going on. In any case, the market has already priced in what we know to date.
“The way to interpret these results is simply that Democratic Presidents have presided over periods when the world has done better relative to expectations than the world did when Republican Presidents were in office,” French says.
“You shouldn’t be basing your investment decisions on who the President happens to be or who controls which house of Congress. You want to focus on the long-term, and stick with the asset allocation that you have built around your specific risk preferences and retirement income situation.”
Moving parts galore
In other words, as important as the US presidential election is, it is impossible to separate out this one variable from the host of others that drive markets day-to-day, month-to-month and year-to-year.
These include the state of the international economy, the commodity price cycle, geopolitical events such as wars and trade disputes, natural disasters and pandemics, technological change, regulation and demography.
Ultimately, as much as we are drawn to tidy stories or narratives, it is the economic and earnings cycles — regardless of who occupies the White House or Downing Street — that are far bigger determinants of market performance.
Separating out a single variable and using it to plot the likely path of stock prices is a bit like trying to read the tea leaves or diagnose sunspots. You risk extracting bogus patterns from what in reality is random noise.
We’ve written on this subject several times in recent weeks. If you found this article interesting, why not try these?
Do the markets really care who wins the election?
Is the stock market Democrat or Republican?
Here are some other recent posts on TEBI you may have missed which we think you’ll enjoy reading:
The story behind Index Fund Advisors
Sport, investing and the paradox of skill
Practitioners still pay too little attention to academia
Investing shouldn’t be a gamble
Are you still playing by the old rules?
The best friend investors have ever heard of
Do you think you’re smarter than Terry Smith?
Picture: Democratic National Committee
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