The economy is shaping up to be one of the biggest issues of the presidential election. That's not surprising as Americans have endured the highest inflation cycle in 40 years, following a surge in the money supply due to trillions in stimulus spending during the pandemic. A recent Motley Fool survey showed 60% of respondents considered inflation a top financial priority in the election.
The good news is the actual inflation rate is nearing the Federal Reserve's target of 2%, but prices remain high, especially in crucial sectors like housing where the country faces an estimated shortage of 4.5 million homes, according to Zillow , after years of underbuilding.
The stock market is often seen as a key barometer for the economy. After all, major indexes like the S&P 500 (SNPINDEX: ^GSPC) , Nasdaq Composite , and the Dow Jones Industrial Average are reported on every day by major news outlets. If a recession were to take place, for example, one of the first signs would likely be a declining stock market.
Naturally, after several years of uncertainty, investors are wondering which candidate would be better for the economy and the stock market.
Which political party is better for the stock market?
Based on historical averages, the stock market has performed better under Democratic presidents in modern history.
Since 1957, when the S&P 500 was created, the index has produced an average compound annual growth rate (CAGR) of 7.4%, not including dividends. Under Democratic presidents, the index has seen a CAGR of 9.8%, while the CAGR has been just 6.0% under Republican presidents.
However, the median return under Republican presidents has actually been higher at 10.2%, versus 8.9% under Democrats. Based on that data point, you could argue the stock market has been stronger under Republican presidents.
Factoring in the status of Congress yields a different set of results. One data set that goes back to 1926, when the S&P had much fewer than 500 companies, found that the returns under unified Republican and Democratic administrations, meaning when Congress was controlled by the same party as the president, were nearly identical.
In the 13 years when a Republican government controlled the White House and both houses of Congress, the average annual return on the S&P 500 was 14.5%. In the 36 years when Washington was under Democratic control, the index returned 14.0%.
A divided Congress with a Democratic president yielded a 16.6% return in the 15 years that occurred, while in the 34 years a Republican president had a divided Congress, the S&P 500 generated a return of just 7.3%.
Does the president matter for the stock market?
It's important to remember when looking at data like this that correlation does not equal causation. The relationship between which party rules the White House and the performance of the stock market is tenuous.
For example, since 1957, the stock market performed best under President Bill Clinton, when the S&P 500 rose by a compound annual rate of 15.2%. Clinton's era benefited from the dot-com boom and the advent of the internet, but he left office before most of those gains were erased when stocks tumbled through 2001 and 2002. Had Clinton's term lasted another year or two, his CAGR would have been much worse.
The president has little direct control over the economy or the stock market, which makes it much different from areas like foreign policy, environmental policy, and Supreme Court appointments. Additionally, there's a lot of randomness and cyclicality to consider.
While it's true the president can influence economic policy and set the tone for the country, the U.S. economy is dominated by the private sector. Roughly 88% of U.S. gross domestic product (GDP) comes from the private sector, and businesses want to maximize profit regardless of who the president is.
The recent boom in the stock market, attributed to artificial intelligence (AI), has been driven by companies like Nvidia and Microsoft , and it was triggered by the launch of OpenAI's ChatGPT. Stocks have surged since then, but giving credit to President Biden for those gains is a mistake.
Additionally, the White House does not even control the primary economic levers that the federal government operates. For example, the Federal Reserve controls monetary policy through the federal funds rate, and it controls the money supply by buying and selling securities.
Congress, meanwhile, controls fiscal policy such as the federal tax rates and federal budget. The president may be able to influence these institutions, but they do not have direct control over them.
Why the stock market will be higher in four years
Right now, the conditions look good for an extended bull market going into the next presidential administration. The Federal Reserve is expected to start lowering interest rates next month. Unemployment is still relatively low at 4.3%, and inflation has finally cooled to near the Fed's target of 2%.
Meanwhile, new artificial intelligence technologies should continue to drive the stock market higher through billions of investments and new products as companies push toward artificial general intelligence (AGI) and innovations like self-driving cars.
As important as the upcoming election is, it's a mistake to base your investment decisions on who ends up in the White House -- the connection is not as strong as it's made to seem.
Right now, the stock market looks poised to continue climbing over the next four years, regardless of who's occupying the White House.
Before you buy stock in S&P 500 Index, consider this: