It's no surprise that a Presidential election affects the economy and markets. What is striking, however, is just how much the political cycle affects the business cycle. Ever since Harry S Truman trumped Thomas E. Dewey in 1948, the economy, the unemployment rate, and the stock market have done better on average in the year running up to the election, only to fall off the following year. The Standard & Poor's 500-stock index has averaged a 9.69% gain in an election year, and only a 4.01% increase the year after.
Of course, there are notable exceptions. In the year leading up to George H.W. Bush's 1988 defeat of Michael Dukakis, for example, the stock market rose 7.7%, and went on to gain almost 26% the next year. And investment managers warn against taking too simplistic an approach in trying to profit from a Presidential contest. "The election is part of a long list of variables that affects stocks," cautions Bob Doll, vice-chairman and chief investment officer of equities at BlackRock, the global investment and money-management firm.
One way investors try to play the election year in a focused way is through political portfolios Wall Street firms tend to roll out as the first Tuesday in November nears. These are simply lists of stocks in industries pundits think should become more profitable based on who becomes No. 44. For instance, the research firm International Strategy & Investment (ISI) is working on a John McCain equity portfolio and a Barack Obama portfolio, which should come out shortly.
The key to creating such portfolios is finding industries that would be most affected by clear policy differences between the candidates. For example, McCain is considered friendly to traditional energy and natural resource companies, such as those in coal and oil. The industry has contributed more than $4 million to Republicans this political season, according to the Center for Responsive Politics, compared with the $2.8 million the industry gave to Democrats. But if a Democrat wins the Presidency, with a Democratic Congress, "we've been telling investors we'll see more emphasis on clean energy, like wind and solar," says David M. Darst, chief investment strategist at Morgan Stanley's Global Wealth Management Group.
The investment banking industry is expected to fare better if McCain wins, since any new regulatory burdens are expected to be less onerous under a Republican Administration. The construction industry, however, could do better under Obama, given his emphasis on improving infrastructure.
The drug industry opens up another potential fault line between the candidates. McCain is seen as more likely than Obama to leave Big Pharma alone as President. With an Obama Administration, Darst would expect a greater focus on generic drugs.
A growing number of companies are signaling to investors that the political cycle matters to their bottom line. The Web site footnoted.org, which specializes in combing through regulatory filings companies provide to the Securities & Exchange Commission, notes that more health-care companies are emphasizing election-related risks. It cites a recent filing by insurer eHealth: "Certain candidates for the 2008 Presidential election have espoused...variations of a universal health-care system that would require a substantial number of individuals to purchase or otherwise obtain health insurance for themselves and/or their children. We cannot be certain of the impact of any new legislation...but it could harm our business, operating results, and financial condition."
Of course, a lot can happen between campaign stump speeches and the oath of office. In 1992, Bill Clinton ran on a platform that included heavy investment in infrastructure to shore up aging roads and bridges. Yet when he took office, it turned out he didn't have congressional support. The planned spending boom never happened. "We have a balance of power that doesn't let ideas that people think are too big happen," says OppenheimerFunds economist Brian Levitt.