Professional investors often think they have no political bias. However, research shows that this is not true. Political bias is proven to cost investors who may over- or under-estimate the state of the economy depending on which party they favor.
In a Nasdaq story published in June, investor Martin Tiller noted how many left-leaning investors dumped stocks after Donald Trump's 2016 victory, just as right-leaning investors did after Barack Obama's 2008 victory, both fueled by perceptions that the wrong party had it. win the election and the economy will pay the price. However, the S&P 500 has been rising in the months following each presidential inauguration, fooling investors who let their biases get in the way.
Academic research suggests this is a widespread phenomenon. A 2017 study on Journal of Financial Markets highlighted how individuals' behavior changed when their preferred political party held the White House. Research has found that, when their favorite group is in charge, investors become more optimistic, see the markets as less risky, and increasingly invest in high-beta, small-cap, and value stocks. As a result, nonpartisan investors have consistently outperformed their Democratic- and Republican-leaning counterparts, according to a University of Chicago study of fund performance from 2015 to 2021.
Political bias affects not only market sentiment but also stock selection. Mutual fund managers tend to hold on to losing stocks issued by politically affiliated companies for longer than they should, a behavior known as the “behavioural effect,” according to a University of Kansas study of nearly 1,300 mutual funds between 2000 and 2015. in other words, fund managers may overestimate the ability of companies led by managers who share their political beliefs. The researchers found that funds with more politically motivated stock picks had lower risk-return ratios.
Political bias is not limited to equity investors. A 2020 study tracking credit analysts from Fitch, Moody's, and Standard & Poor's between 2000 and 2018 showed that those who disagree with the sitting president's party tend to issue the most frequent downgrades of corporate credit ratings.
However, historical market data provides a realistic reality check. Long-term market performance has proven to be resilient regardless of which political party is in power. The S&P 500, for example, rose despite party shifts in Washington.
While executive decisions from the White House can be big and have long-term implications, markets are often able to work through them. For example, when Trump launched a trade war with China in September 2019, some analysts expected Apple's (AAPL) iPhone sales to drop by as much as 8 million units and its stock price to drop. Over the next 12 months, Apple stock rose 160 percent compared to the S&P 500's 16 percent. Likewise, after President Biden's inauguration, many expected his green energy policies to hurt oil and natural gas companies. And yet, Morningstar data finds that US energy companies have outperformed the S&P 500 over the past year.
Political sentiment can influence how major shareholders vote on corporate policies. Big mutual funds and asset managers tend to vote closely with the ruling political party at the time, according to a joint study by the City University of Hong Kong and INSEAD published in International Banker. When examining shareholder voting behavior between 2004 and 2021, researchers found that major asset managers were significantly more likely to support environmental and social initiatives when a Democrat was in the White House than when a Republican was in office.
However, instead of bias being disrupted, another possible explanation is that large asset managers, such as BlackRock (BLK), StateStreet and Vanguard, may be acting in favor of the prevailing political party to avoid legal scrutiny. Further reinforcing their findings, the researchers noted that voting behavior on business policies unrelated to environmental and social justice issues remained the same, regardless of which political party was in power.
The data confirms that the stock market reflects the jitters of investors' choices. The VIX, an index measuring stock market volatility, is about 6 percent higher during election years than in other years. Higher VIX readings increased expected volatility and increased market uncertainty for investors.
