The Presidential Puzzle: Why Stock Returns Favor Democrats

Short version

While many investors believe Republican administrations are inherently better for the stock market, nearly a century of data suggests the opposite: the equity risk premium has been vastly higher under Democratic presidents. This 'presidential puzzle' is best explained not by the superiority of liberal economic policy, but by the timing of when voters choose their leaders based on their own appetite for risk.

Since 1927, the average excess return for stocks has been roughly 10.3% under Democrats compared to just 2.2% under Republicans.
The 'Presidential Puzzle' suggests that Democrats are often elected during crises when risk aversion is high, leading to higher expected future returns.
Republicans tend to be elected during periods of economic prosperity and low risk aversion, when market valuations are already high and future returns are likely to be lower.
Despite these cyclical differences, raw stock returns have remained reliably positive under both parties, making market timing a dangerous strategy.

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Historical data shows that the equity risk premium is significantly higher under Democratic presidents, but the reason has more to do with risk aversion than policy.

The Psychology of the Ballot Box and the Portfolio

The 2024 U.S. presidential election has, like many before it, triggered a wave of partisan speculation regarding the future of the stock market. Investors often view elections through the lens of their own worldviews, a phenomenon documented in the 2020 paper 'Belief Disagreement and Portfolio Choice.' The study found that after the 2016 election, Republican-leaning households increased their equity exposure, while Democratic households retreated into safe assets. Both groups were looking at the same public information but interpreting it through different models of reality.

The danger of investing based on political affinity is that individual beliefs are rarely a robust proxy for how global markets actually function. While a Republican victory might feel like a 'green light' for a conservative investor, the historical data offers a much more complicated—and perhaps counterintuitive—narrative. To understand where the market may be headed, we have to look past political rhetoric and toward a phenomenon known as the 'presidential puzzle.'

Decoding the Presidential Puzzle

The presidential puzzle refers to a striking empirical fact: the vast majority of the historical U.S. equity risk premium has been delivered under Democratic presidents. Data spanning from 1927 to 2015 shows that the average market return in excess of three-month Treasury bills was 10.7% per year under Democrats, compared to a staggering negative 0.2% under Republicans. Even when we update this data to include the most recent Trump and Biden terms, the trend persists. From 1927 through October 2024, the annualized equity risk premium stands at 10.29% under Democrats and 2.23% under Republicans.

It is tempting to attribute this gap to specific economic policies, but markets are generally too efficient for such a simple explanation. If one party’s policies were consistently superior for growth, investors would price that in the moment the election results were finalized. Instead, the persistent nature of this return gap suggests that the cause is not the president’s actions, but the conditions present at the moment they take office.

Risk Aversion as a Political Catalyst

A more robust explanation, offered by researchers in the Journal of Political Economy, centers on 'time-varying risk aversion.' Essentially, the mood of the electorate shifts in tandem with the economy. When the country is in the midst of an economic crisis, risk aversion is high. In these moments of fear, investors demand a higher premium for holding stocks, and voters simultaneously demand more social insurance, leading them to elect Democratic presidents. Examples abound: FDR was elected during the Great Depression, Obama during the 2008 financial crisis, and Biden during the height of the COVID-19 pandemic.

Conversely, when the economy is booming and the stock market is hitting all-time highs, risk aversion is low. Voters feel more comfortable taking business risks and often elect Republicans to lean into that prosperity. Because these presidents are elected when valuations are already stretched and optimism is peaked, the 'expected' future returns are naturally lower. In this model, Democratic presidents do not cause high returns; rather, the high-risk environment that gets them elected is the same environment that sets the stage for a market recovery.

The 2024 Context and Future Expectations

Applying this model to the current moment provides a sobering perspective. Donald Trump is set to inherit an economy that is objectively performing well, with stock prices near record highs. This suggests that risk aversion is currently low, which historically correlates with lower future returns. Major institutional forecasts align with this: Vanguard projects U.S. stock returns between 3.2% and 5.2% over the next decade, while PWL Capital estimates roughly 6.5%. Both figures suggest that U.S. equities may trail international markets in the coming years.

While Republicans are often associated with market-friendly policies like tax cuts, these effects are frequently 'swamped' by the broader cyclical forces of the presidential puzzle. A short-term bump in stock prices due to anticipated corporate tax relief may occur, but it often fails to offset the long-term reality of starting a term at the peak of a business cycle. The historical tendency for a downturn to occur shortly after a Republican takes office is less about their platform and more about the exhaustion of the preceding bull market.

The Case for Political Neutrality in Investing

Despite the compelling nature of the presidential puzzle, it should not be used as a tool for market timing. Predicting the future remains notoriously difficult, and even the most robust models have outliers. For instance, those who exited the market in 2016 because they feared a Trump presidency missed out on four years of exceptional returns. Similarly, while the risk premium is lower under Republicans, raw stock returns have remained reliably positive on average across both parties. You are not necessarily losing money under a Republican; you are simply being compensated less for the risk you are taking.

The most sensible path forward is to remain globally diversified and emotionally detached from the headlines. Politics is an emotional business, but investing should be a clinical one. By delegating portfolio management to automated products or advisors who adhere to evidence-based strategies, investors can protect themselves from their own biases. Whether the White House is red or blue, the fundamental principles of low-cost, diversified, and long-term investing remain the most reliable path to wealth.

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