Food for thought on political cycles and stock returns

There is a well know stock effect in the US based on the political party in power. Periods of Democratic presidencies see higher stock returns than Republican administrations. The excess return difference is significant and greater than 10 percent as measure between 1927 and 2015. The last four years, while different, does not change the long-term relationship. A recent working paper has tried to answer this political cycle effect through an endogenous model of economic behavior. See "Political Cycles and Stock Returns" by Pastor and Veronesi.

Their simple model is based on the market response to time varying risk aversion. It is not what president do but when they are elected. When risk aversion is high such during a crisis, voters will more likely elect a Democratic president who will more likely provide greater social insurance. When risk aversion is low during periods of economic boom, voters will more likely elect a Republican because they are willing to take more business risk. 

Higher (lower) risk aversion under Democratic (Republican) administrations will result in a higher (lower) equity risk premium and thus higher (lower) stock returns. The authors show that there is direct link between risk aversion and voter preference. 

Is this year going to be different from the endogenous political cycle story? Economic growth has rebounded, uncertainty is still high, the pandemic crisis has not ended, and the need for social insurance still exist. This environment fits the story for a Democratic administration which is consistent with even late poll numbers, yet the uniqueness of the current crisis and strong voter turnout may make this election closer than forecast.