As Sam Sees It: Which Presidential Candidate is the Market Voting For?

Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.

EQ: In this week’s Sector Watch report, you looked at who may be the likely beneficiaries for the upcoming election. Historically speaking, the market seems to favor one party’s administrations over the other, but it’s not the one most would expect. Can you tell us more about that?

Stovall: While many people regard Wall Street as being fiscally conservative, and therefore more likely to support the Republican candidate. Others regard the Democrats as the tax-and-spend party, and therefore, poison to any portfolio. As a result, they believe the stock market and economy have performed better under Republican presidents than Democrat presidents. Yet, history shows the opposite to be true as the U.S. economy, stock prices, and corporate profits recorded greater growth during Democratic administrations than Republican ones.

Specifically since 1900, the S&P 500 rose a median 12.1 percent in price during each year that a Democrat occupied the White House as compared to a median 5.1 percent gain under Republican administrations. In addition, since 1949, U.S. real GDP increased a median 4.2 percent per year under Democrats versus 2.6 percent per year under Republicans. Finally, S&P 500 GAAP earnings—which are sometimes called “as reported” earnings—rose a median 10.5 percent per year during Democratic administrations as compared to a median 8.9 percent under Republicans. So while one might say that the Democrats are the tax-and-spend party, the important part of the equation could be the word “spend.” When you spend, it usually improves the economy and increases corporate earnings.

EQ: After breaking down which sectors and sub-industries would benefit under an Obama or Romney administration, it seems that Industrials may not be as excited for a second term under the current administration. What are some of the reasons for that?

Stovall: Well, first off, Industrials are your deeper cyclical categories–specifically such areas would be Aerospace and Defense, Air Freight and Logistics, other transportations like Railroads and Trucking, as well as Industrial Machinery, Conglomerates, Construction and Engineering, and others. What’s interesting is when I asked S&P Capital IQ’s equity analysts to give me those sub-industries that would benefit from either an Obama or a Romney victory, none of the analysts could point to a particular sub-industry that would benefit from an Obama victory in the Industrial sector. They pointed out that the Defense category is likely to be experiencing a very sharp cut back in expenditures under an Obama reelection, whereas the Republicans are typically more in favor of a greater effort toward national security.

One of the factors that have taken quite some time in coming to conclusion is the Keystone oil pipeline project. It appears that Republicans are more likely to push this project along to ensure that we get good shale oil coming from Canada, rather than Canadians deciding the U.S. is waiting too long and sending it to Vancouver instead. In terms of railroads, about 25 percent of revenues come from coal shipments. Since the Democrats have said that they prefer alternative fuels and less CO2 intensive fuel–and that there would be a penalty for coal-fire utilities, etc.–that could cut back on the railroads’ profits because so much of their revenue derive from the shipment of coal. Railroads would also benefit if we have the Keystone pipeline because of the construction equipment that would be moved around to facilitate the building of the pipeline, as well as the removal of a lot of the debris.

There is one benefit in terms of Railroads for Obama and that would be his desire to maintain ethanol as an additive to gasoline. Grain is one of the larger volume items being shipped by railroads, though certainly not as big as coal, but railroads have benefited from the use of ethanol in order to deliver the coal from the fields to the plants.

In general, we really could not find any one particular industry in Industrials that would benefit from an Obama reelection, but rather only part of a sub-industry that could benefit (railroads), but less than under a Romney victory.

EQ: The possible increase on taxes for dividend income may take some shine off of these stocks for income investors, particularly those in the Utilities and Telecom sectors. How could the election results impact the high-yielding sectors?

Stovall: There are two ways to look at that. If the Bush tax cuts are allowed to end, it would force the taxes on dividends to rise by almost three times, going from 15 percent up to about 44 percent if you include the investment tax that was passed by Affordable Healthcare for America Act. So first, you have to ask if that is going to stop Consumer Staples, Telecom and Utilities companies from issuing dividends. The answer is probably no, because these companies have increased their dividends under a variety of administrations and a variety of tax policies in the past. These companies know that many of the people who own their stocks are income seekers, so they’ll probably continue to raise their dividends.

The second perspective, however, is the reception by the investing public. With interest rates being as low as they are–basically nonexistent in money market funds–investors have been gravitating toward the high dividend yielders because of the income and how favorable the dividends have been treated. With income being taxed at 36 percent but dividend yields being taxed at only 15 percent, dividends are much more favorable and kind to investors. Should we end up with the Bush tax cuts going away, however, we might find that fewer investors will be attracted to dividend yields and could be in search of other areas. One area that could benefit would be the real estate investment trust (REITS). These are currently taxed at a much higher rate than qualified dividends. So if the more favorable tax rate for qualified dividends goes away, then that would make the yields on REITS much more competitive.

EQ: Previously, you covered the topic about the S&P 500’s price performance during July 31 through October 31 as an accurate predictor of the next president. Could tracking the sectors and sub-industries that you’ve broken down in your most recent report help that prognostication?

Stovall: That would be a very sophisticated way of trying to figure out whether Obama or Romney would get elected. I think there’s probably a simpler way of doing that. First off, the reason why it would be challenging to do is we have to assume that those groups that we think will benefit from either an Obama or Romney victory would indeed benefit from them and be reflected in share price movements. Therefore you’re probably better off just looking at the S&P 500 itself because the track record has been so convincing.

Since 1900, if the market has risen between July 31 and October 31, the incumbent has been reelected 80 percent of the time. If the market has fallen in that timeframe, the incumbent has been replaced 88 percent of the time. If you do a correlation between a rolling 50-day price change of the S&P 500 and a rolling 50-day poll for Obama or Romney as found on Intrade.com, you’ll find that since April 30, when we had a pretty clear idea that Romney would be the candidate for the Republicans, the correlation with the market between Obama and the S&P 500 has been 81 percent. For Romney, the correlation is minus 61 percent. So whenever the market has risen, the numbers for Obama have gone up. Whenever the market has fallen, the numbers for Romney have gone up. Basically, the market’s movement has been pretty much in opposite direction with Romney, but pretty much in lockstep with Obama.

That would indicate to me that this year the presidential predictor is again signaling that if the market advances in that three-month period, President Obama will be reelected. If the market declines, then challenger Romney will be elected.