Blog - Investing Notes

July 26, 2007 - Political Influences on Stock Valuation Levels

Do political factors influence stock valuation levels? In his July 2007 paper entitled "Can Political Factors Explain the Behavior of Stock Prices Beyond the Standard Present Value Models?", Tomasz Wisniewski explores the degree to which political factors affect valuation of U.S. equities. Specifically, he examines whether party holding the Presidency (12 presidencies), Presidential approval ratings and timing of eight major military conflicts affect stock price levels relative to rational valuation models. Using data from a variety of sources for the period 1945-2005, he concludes that:

• Stocks tend to be overvalued (undervalued) when Democrats (Republicans) hold the Presidency.
• Stock valuations are high (low) when Presidential approval ratings are high (low).
• Stocks are particularly overvalued during election years.
• Major military conflicts depress stock valuations, mostly during the first year of a conflict.

In summary, U.S. stocks tend be be most overvalued under Democratic Presidents, under popular Presidents, during election years and during years when no new major military conflicts start.

However, to exploit valuation trends derived from these political factors, an investor would have to predict political events more quickly and accurately than competing investors.

Note that part of this study assumes two asset valuation regimes, one Democrat and the other Republican, in power at different times across 61 years of annually measured stock valuation levels. However, the sample spans only seven changes of party-in-Presidency. It is more appropriate to measure valuation levels by party-in-power regimes (four Democrat and four Republican) rather than by year, resulting in a very small sample. Further complicating interpretation based on party labels, it seems obvious that the valuation environment when one party holds both the Presidency and both houses of Congress differs from that when power is split.

For related research, see Blog Synthesis: Politics and the Stock Market. See especially our blog entry of 8/22/06 for a possible explanation of overvaluation (undervaluation) when Democrats (Republicans) hold the Presidency.