Stocks move in predictable ways after White House change

ITHACA, N.Y. – With President-elect Donald Trump’s inauguration approaching, the stock market has been more volatile because investors are trying to predict which industries will do well under a Trump administration – and which will tank.

According to a new Cornell University study, there is a way to capitalize on this fluctuation because stock returns in politically sensitive industries fall into predictable patterns after a new president is elected – and the effect is twice as strong when there’s a change in party.

“Some industries that were favored by the previous administration tend to perform poorly when there’s a change in power,” said Jawad Addoum, co-author of the study and Cornell assistant professor of finance. “That’s what our strategy says: you need to flip the portfolio now, and take advantage of stock returns in politically sensitive industries starting to move in a predictable way in opposite directions.”

But there’s another key factor at play, the researchers said.

Sophisticated market players known as arbitrageurs, who normally balance out market fluctuations with their own buying and selling activity, choose instead to exit the market to avoid exposure to risk.

“When there’s a change in power, there may be too much uncertainty for arbitrageurs to handle. They seem to just get out of politically sensitive sectors,” Addoum said.

With arbitrageurs out of the game, the political sentiment of retail investors and mutual fund managers drive prices and returns.

Models in the study produced monthly risk-adjusted returns of 1 percent during the six months surrounding presidential elections from 1939 through 2011, determining which industries earned better returns under a Democrat president versus a Republican.

For example, tobacco, candy and soda, and lab equipment have traditionally performed well during Republican administrations. Under Democrats, electronic chips, real estate and construction have earned better returns. More recently, coal has performed better under a Republican president, while health care has done better under a Democrat.  Overall, these politically sensitive industries made up between 17 percent to 27 percent of market capitalization, the researchers found. “This is not a dusty corner of the market,” Addoum said.

The study, “Political Sentiment and Predictable Returns,” was published in The Review of Financial Studies.

 

Cornell University has television, ISDN and dedicated Skype/Google+ Hangout studios available for media interviews. For additional information, see this Cornell Chronicle story.

 

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