Political influences on Dow Jones Industrial Average Index returns: perception and reality

International Journal of Business Research, Jan, 2008 by Haiwei Chen, Jim Estes, Greg Richey

ABSTRACT

In this study, we provide a thorough examination of the notion that the Dow Jones Industrial Average Index does better under a Republican administration. Using data from 1901 to present, we identify the period in which Republicans control 1) the White House and 2) the White house, House of Representatives and the Senate. We find that the party affiliation of the Presidency has no effect on returns. The effect from political gridlock has little impact on returns in that the returns during the period of complete control by the Republicans are not significantly different from that during the period of complete control by the Democrats. However, confirming the results in previous studies, returns are significantly higher during the second half of a Presidency than during the first half.

KEYWORDS Political Stock Market Cycles, Dow Jones Index, Political Party

1. INTRODUCTION

One of the popular perceptions is that the Republican Party is friendlier to big business than is the Democrat Party. As a result, it is expected that stocks of those larger corporations do better under a Republican administration. Such a perception is termed the "political stock market hypothesis."

Empirical results are mixed. For example, Nofsinger (2007) examines monthly Dow returns from 1900 to 2004 and find an insignificant coefficient for the dummy variable for president. His conclusion is that the election of a president does not predict the direction of the stock market. Powell, Smith, and Whaley (2007) use CRSP Index monthly stock market returns from 1927 to 1998. They find that presidential regime differences are insignificant. Beyer and Johnson (2004) examine monthly returns for two equity indexes, two fixed-income indexes and an inflation index. They conclude that political gridlock is not beneficial to security market performance and that Fed policy mainly dominates political considerations in security market performance. Furthermore, Johnson, Chittenden, and Jensen (1999) use annual data from 1929-1996 for the S&P 500, a small-stock index, long-term corporate bonds, long-term government bonds, and T-bills. They find that small-cap stock returns are higher during Democratic administrations; however, bond index returns are shown to be significantly higher during Republican administrations.

On the other hand, Santa Clara and Valkanov (2003) examine monthly value-weighted and equalweighted CRSP stock market index returns between 1927 and 1998. They find that the excess return of the value-weighted CRSP portfolio over the one-month T-bill is on average 9% higher under Democratic than under Republican administrations and volatility is higher under Republican administrations. In addition, Booth and Booth (2003) apply annual stock returns (large-cap portfolio and small-cap portfolio) from 1803 to 1996. They find that both large-cap and small-cap stock returns in the US exhibit a presidential cycle pattern; returns are significantly higher in the last 2 years than in the first 2 years of the presidential term.

This study provides an in-depth analysis of the effects of a Presidency's political party affiliation and the control of political system on the Dow Jones Industrial Index (DJII) returns. The DJII is composed of the 30 largest US corporations.

2. DATA AND METHODOLOGY

We use dividend-adjusted monthly returns for the DJII from February 1901 to September 2007. Panel A of Table 1 presents summary statistics. A simple t-test confirms that the monthly returns are significantly different from zero, which implies a positive trend in the level of DJII.

We identify the party affiliation of the occupants of the White House in each administration and two chambers of Congress. Panel B of Table 1 shows the tabulation. The Republican Party controls the presidency about 55% of the time. In addition, republicans control the senate about 55% of the time. In contrast, the democrats control the house about 55% of the time. About 48% of the time there is political gridlock, whereby no single party controls both the Presidency and Congress.

[FIGURE 1 OMITTED]

Figure 1 depicts the returns and the control of the presidency. A casual examination does not reveal any obvious correlation between the return and political control.

We then divide the period into sub-periods during which one political party controls both the Presidency and Congress or neither party controls both and calculate returns in each period. We use both the parametric t-test and the non-parametric Wilcoxon test. The non-parametric test is deployed to account for the presence of outliers in the data. In addition, regression analysis is also conducted.

3. RESULTS

Table 2 presents further comparison of returns from different sub-periods. Panel A shows that returns under a Republican President are not significantly different from those gained under a Democratic President. Notice that results from both the t-test and the nonparametric test are consistent.

Panel B shows the results for political gridlock. Once again, the returns are not different under gridlock from under no gridlock. Finally, Panel C shows results for the duration of the Presidency. The returns are significantly higher during the first half than during the second half. This result is consistent with those in Booth and Booth (2003).