“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us.”
These words, from the opening of Charles Dickens’ “A Tale of Two Cities,” are among the most famous in all of English literature. Today they could easily apply to how investors view the outlook for the U.S. economy and our stock market.
Politics Affect Investors’ Market Perceptions
Whether you view the outlook for our economy and stock market as entering the best of times or the worst of times is highly dependent on your political perspective. Research on investor behavior has found that individuals become more optimistic and perceive the markets to be less risky and more undervalued when the party they favor is in power.
This leads them to take on more risk. They also trade less frequently, which is a good thing, because the evidence demonstrates that the more individuals trade, the worse they tend to do. But when the opposite party is in power, investors’ perceived uncertainty levels increase, and they exhibit stronger behavioral biases, leading to poor investment decisions.
You can observe just how strong the impact of these biases can be in the Spectrem Group’s December 2016 Affluent Investor and Millionaire Investor Confidence survey. Prior to the presidential election in November, survey respondents who identified as Democrats showed higher confidence than those who identified as Republicans or Independents. This completely flipped following the election, when Democrats registered a confidence reading of -10 while Republicans and Independents showed confidence readings of +9 and +15, respectively.
The February 2017 University of Michigan survey of consumer confidence provides further evidence. It showed Republican confidence sentiment at 120. This figure hadn’t topped 112 since 1952. For Democrats, the confidence reading was just 55.5, a level not seen since the last recession, when the economy was shedding 2 million jobs a month. Echoing Dickens’ now famous words, Republicans apparently think it’s the best economy in the postwar era, while Democrats seem to think it’s the worst since the financial crisis.
Here’s one more example. Before the 2000 election results were announced, Democrats were slightly more optimistic than Republicans. However, after the announcement of George W. Bush’s win, that changed dramatically. Roughly 62% of Democrats were optimistic about the stock market before the election, but that figure fell to just 36% in early 2001. The optimism about the overall economy was similarly affected.