Donald Trump won the 2024 US presidential election and is set to become the 47th president of the United States. This Republican victory likely contains information about expected stock returns, but it's probably not the information that you expect to hear. An interesting empirical fact is that the

historical equity risk premium going back to 1927 has been much higher under Democratic than Republican presidents. This has been referred to as the presidential puzzle, and its explanation may have implications for expected US stock returns today. I'm Ben Felix, Chief Investment Officer at PWL Capital, and

I'm going to tell you what politics can tell us about expected stock returns. Everyone is going to have a different opinion on what the recent election results mean for the stock market. One of the problems with opinions is that everybody has one based on their own

model of the world. The 2020 paper, "Belief Disagreement and Portfolio Choice", finds that households likely to be Republican increase the equity share and market beta of their portfolios following the 2016 presidential election, while likely Democrats rebalance into safe assets. The authors control for multiple factors to

rule out non-belief based explanations, concluding that the behavior is driven by investors interpreting public information using different models of the world. This is both obvious and kind of crazy to think about. Democrat households in 2016 believed Trump would crash the market and went to cash, while

Republican households believed that Trump would kickstart the rocket ship and they increased their allocation to stocks. The problem, of course, is that individual beliefs are not a great model for how the world actually works. Making decisions on that basis is likely to lead to errors. Fortunately, there are

more robust models that explain the relationship between political cycles and stock returns. These models were developed in response to an empirical puzzle known as the presidential puzzle. The empirical fact here is striking: the vast majority of the historical U.S. equity risk premium has been delivered

under Democratic presidents. This is based on a November 2020 paper in the Journal of Political Economy looking at data up to 2015. The headline empirical result discussed in the paper is that from 1927 to 2015, the average market return

in excess of three-month treasury bills under Democratic presidents is 10.7% per year, while under Republican presidents it is negative 0.2% per year. The theoretical explanation is the meat of the paper and what makes the paper interesting today. I'll get there in a

minute. The overall return difference of nearly 11% per year is economically and statistically significant. Stock returns under the most recent Republican (Trump) and Democratic (Biden) presidential terms don't fit with the model. The equity risk premium under Trump was an annualized 14.4%, while it has been 9.12% so far

under Biden (ending October 2024). No model is perfect, but they can still be useful. When I include those more recent data in the larger data set back to 1927, the overall results stayed directionally the same, with the average equity risk premium under Democratic presidents far

exceeding Republican presidents. In my updated data set from 1927 right up to October 2024, the equity risk premium is 10.229% annualized on average when the president is a Democrat and 2.23% when

The president is a Republican. This empirical puzzle was first identified in a 2003 paper in the Journal of Finance, "The Presidential Puzzle, Political Cycles, and the Stock Market," and found to persist out of sample in the 2020 paper, "Political Cycles and Stock Returns."

The tempting explanation for the puzzle is the different economic policies that the two parties represent, but that's not really how markets work. The expected effects of economic policies are quickly reflected in stock prices. That explanation would imply that investors persistently misprice stocks by

failing to anticipate the expected policy effects. There is a simpler explanation offered by the authors of "Political Cycles and Stock Returns." Democrats tend to get elected when expected future stock returns are higher, and Republicans tend to get elected when they are lower. This could happen because

investors' aversion to risk varies over time depending on what's happening around them. For example, risk aversion is likely to be high during an economic crisis. When risk aversion is high, investors demand more compensation for taking risk, which on average plays

out as higher realized stock returns. How this relates back to politics is that when risk aversion is high, like during an economic crisis, voters are more likely to elect a Democratic president because they demand more social insurance. Well, when risk aversion is low, like during a booming economy and stock

market, voters are more likely to elect a Republican president because they want to take more business risk. The result is that when Democrats get elected, risk aversion tends to be higher, leading to higher expected stock returns, and when Republicans are elected, risk aversion tends to be lower, leading to lower

expected stock returns importantly in this model, democratic presidents do not cause high expected stock returns. High risk aversion causes both democratic presidents to get elected and expected stock returns to be high at around the same time. It's a similar story in the other direction for Republican

presidents. They do not cause stock returns to be low, but low risk aversion tends to result in Republican presidents getting elected and expected stock returns being low. Going back through history, the model seems to make sense. In November 1932, in the midst of the Great

Depression, Republican Herbert Hoover lost the election to Democrat Franklin Roosevelt. Kennedy was elected during the 1960-61 recession, Carter after the 1973-75 recession, and Clinton after the 1990-91 recession. In November 2008, in the depths of the great financial crisis,

Democrat Obama beat Republican John McCain, and then in 2020 Democrat Biden beat Republican Trump as the United States and the rest of the world navigated the COVID-19 pandemic. In 2024, with the US economy looking objectively pretty great and US stock prices nearing

all-time highs, Republican Trump beat Democrat Harris. This all makes sense in the model of democratic presidents being elected when risk aversion is high and Republicans when it is low. Overall, transitions from Republican to democratic presidents tend to be preceded by low market returns, low GDP

growth, and high volatility, further supporting the model. The time series of four proxies for risk aversion indicate that risk aversion tends to start out high and then decline over the course of a democratic presidency. This change in risk aversion contributes to such a large gap between returns under

Democrats and Republicans as risk aversion reverts to the mean after a Democrat is elected, expected returns fall and stock prices increase, fitting with the model and with history. Trump will likely be inheriting a stock market with high valuations related to low risk aversion. Republicans are most likely to

get elected when risk aversion is at its lowest, often at the peak of the business cycle, and it is therefore not surprising to observe a downturn shortly after a Republican takes office. This model predicts a larger return gap in the early years of presidential terms, which

is exactly what we see in the data. In the 1927 to 2015 data, the gap in returns is largest in the early years of presidencies. This model is highly relevant today. The US economy is objectively doing well and stock prices are high, indicating that risk of

aversion and expected returns are low. Vanguard's Capital Market expectations indicate that US stock returns will be between 3.2 and 5.2% for the next 10 years, trailing global ex-US stocks by a wide margin. PWL Capital has a slightly

higher expected return at 6.54%, but we similarly expect US stocks to trail global ex-US stocks. One argument often given for why Republicans are good for the stock market is that they are more likely to lower taxes. It is true that after Republicans are elected, the

stock market tends to respond favorably in the short term, likely due to the expectation of higher after-tax cash flows for corporations. While this effect is well documented, it is completely swamped in magnitude by the presidential puzzle, which unfolds over a longer period. What you should do with this

This information depends on your confidence in the model. If you knew for sure that things would play out similar to the past, you might change your asset allocation to reflect those expectations, but you don't have that much confidence, at least you shouldn't. Nobody can predict the future and economic models

only make conditional predictions. There are too many confounding factors that can affect actual outcomes. I would not use this information to time the market. The presidential puzzle analysis looks at the equity risk premium, which is the premium for owning stocks over short-term government bonds, but raw

stock returns have been reliably positive on average through Democratic and Republican leadership. We're not talking about losing money by staying invested when Republican presidents are in power. The puzzle is that historically the risk of owning stocks has been better compensated while a Democratic

president leads the country, but stock returns have typically been reliably positive no matter what. The most recent out-of-sample period for the political cycles and stock returns paper shows that predicting the future is hard. If you had gotten out of US stocks when Trump was elected the first time, as I

know many people either did or considered doing, particularly if they were Democrats or held similar beliefs, you missed out on four years of great returns. Even models that have been historically successful at explaining returns are not perfect guides for future decision-making. Caution is warranted in the other direction too,

particularly in light of the model explaining the presidential puzzle. Believing that the incredible recent US stock returns will persist forever at a time when valuations are high and risk aversion is low does not seem wise. Again, I am not suggesting reducing or eliminating US stock exposure, but I

wouldn't be going all in either. Diversification is important, and like an umbrella, you don't want to have to buy it after it starts pouring rain. Individual beliefs affect how people respond to information, like election results. This is not great because individual beliefs are often incomplete

models of the world. Stepping back and looking more objectively at the empirical data, a puzzle emerges: the equity risk premium has been much higher under Democratic presidents than Republican presidents. Likely due to time-varying risk aversion causing expected returns to be high when Democrats are

elected and low when Republicans are elected. While this may make market timing tempting, no model is perfect. And the reality is that while the risk premium has varied, average stock returns have been reliably positive through political cycles. Staying invested in a low-cost, globally diversified portfolio

is, as always, probably the most sensible thing for most people to do. I know politics can get emotional, but don't let your individual beliefs cloud your judgment based on the findings from the previously mentioned paper. One of the best ways to reduce the impact of

individual beliefs on investment decisions is to delegate your portfolio management to an automated investment product, like an asset allocation ETF or to a professional financial advisor. Ideally, one that doesn't have commission incentives to sell you certain financial products. Thanks for watching. I'm Ben

Felix, Chief Investment Officer at PWL Capital. If you want to learn how PWL helps Canadians manage their individual beliefs to make better financial decisions, you can book a meeting with us below.

Trump’s Win and Expected Stock Returns (The Presidential Puzzle)

I post videos on investing, financial decision-making, and living a good life.

My name is Ben Felix. I am a Portfolio Manager and the Head of Research at PWL Capital. I am a CFA charterholder and CFP professional. I am securities licensed in Canada by CIRO.

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Trump’s Win and Expected Stock Returns (The Presidential Puzzle)

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