The growing partisan divide in US investor portfolios
The US elections are just a week away and the outcome will lead to significant shifts in investor portfolios and consumer behaviour. Don’t believe me? Then you haven’t paid attention to the many research papers that document a growing partisan divide in the US not just in political but also in financial matters.
Elisabeth Kempf and Margarita Tsoutsoura summarised the major findings of these studies in a short overview article. While political polarisation is increasing in the UK and Europe as well it is nowhere near as extreme as in the US and I know of no study that shows a meaningful impact of political views on investor behaviour. Yet, in the US, you can see a partisan divide in all kinds of places.
Consumer sentiment surveys are by now so tainted with political views as to have become meaningless. If a Republican is President, Republicans think the economy is doing great and Democrats think it is doing terribly. But when a Democrat becomes President, the sentiment flips on the day of the inauguration, just to flip back once a Republican becomes President again. Apparently, the US economy changes overnight on the day a new President is inaugurated.
Consumer sentiment by party affiliation in the US
Source: Panmure Liberum, University of Michigan
This partisanship is not only a matter of sentiment, but it also has real-world consequences:
Credit analysts provide worse ratings and stronger downgrades in times when the President is of the opposing party, thus raising the cost of debt for affected companies.
The affiliation of corporate bankers with the President’s party influences their syndicated loan pricing decisions.
Republican mutual fund managers increased their net equity holdings by 2% around the time Trump became President and kept this higher level throughout his administration before reducing it again when Biden was elected. They also increased their holdings in cyclical stocks vs. defensives and thus increased portfolio risk overall under Trump.
But nowhere is the partisan divide more pronounced than in ESG investing and attitudes to corporate social responsibility. The chart below shows the share of funds classified as socially responsible funds by the political leaning of the fund manager. ESG funds are much more popular among Democratic fund managers than Republican fund managers.
Share of mandates classified as ESG by political leaning of the fund manager
Source: Hong and Kostovetsky (2012)
And investors have different attitudes to ESG investing as well. Institutional investors in Democrat-run states are more likely to invest in ESG mandates and retail investors in a hypothetical 100% Democrat County are willing to pay 31bps more for an ESG fund than a comparable traditional fund, while in a hypothetical 100% Republican County, they are willing to pay only 12bps more.
One thing experienced investors know is to keep their political views out of their investment decisions. The market does not know whether you are left or right politically and it does not know if a business is left or right. Making investment decisions based on your politics is a guaranteed way to miss out on opportunities.
"The Democrats are the party that says government will make you smarter, taller, richer, and remove the crabgrass on your lawn. The Republicans are the party that says government doesn't work and then they get elected and prove it." -- P. J. O'Rourke
My two cents:
A lot has changed in the US over the past decade, especially since Obama’s second term. The divide is evident across various aspects of society. Reading CNN and Fox News can feel like observing two different countries.
Each side often opposes the other, even when beneficial actions or decisions are taken. Additionally, the party winning the presidential election frequently reverses regulations established during the other party's tenure. Many people and businesses prefer not to have one party control the presidency, Senate, and House simultaneously, as it prevents one-sided agendas and slows down significant regulatory changes affecting businesses.
Significant ideological differences are more manageable when parties are compelled to negotiate because different parties control the House and Senate. This seems to be the ideal situation when the country is so divided. However, if Trump wins the upcoming presidential election, there is a strong possibility that Republicans could gain complete control, potentially leading to significant shifts.
Only time will reveal the impact on our economy and stock market. In 2016, similar fears existed about Trump's election, yet the market thrived unexpectedly.
The stock market is complex, making predictions challenging. As a long-term investor, I remain invested. I've balanced my portfolio after a strong market performance in 2024. Beyond that, I plan to stay the course and buy more stocks if the market declines.
The most significant short-term risk is whether we will get an election result that both parties will accept in the next day or two after polling or whether it will drag on for several months, further dividing the country and creating a significant short-term uncertainly for people, businesses, and the stock market. There is no way to predict!