October 26, 2021 • By Keith Giles
During the COVID-19 pandemic, investors have experienced wild fluctuations in the market, with some companies experiencing significant gains while others suffered. While investors may have their theories for why some organizations weathered the volatile market better than others, there is one significant factor that hasn’t been seriously examined—political alignment.
Thanks to the diligent research of Jinfei Sheng, Zheng Sun and Wanyi Wang of The UCI Paul Merage School of Business, this previously unconsidered element has been documented and verified. The team published their findings in the article titled Partisan Return Gap: The Polarized Stock Market in the Time of a Pandemic.
“In early 2020, from March to April, there was a lot of news about stock markets and some discussion about how political beliefs about COVID may impact the market,” says Sheng. “We wanted to understand the impact of political polarization on stock performance and the pandemic provided the perfect environment for us to gather the data we needed.”
Over the last few years, as partisanship and political tribalism has grown, the divide across party lines has cut through living rooms and board rooms alike. This widening gap between the red and the blue presumably has been a factor in the rise and fall of stock prices as well, but how, why and in what ways? This was what Sheng, Sun and Wang set out of uncover.
Measuring the politics of a company’s investor base
When it comes to determining whether a company is red or blue, the team had to make certain distinctions. “In our paper we rely mainly on the location of the company headquarters,” says Sheng. “Our research shows that the local geographic location is what matters most. Where you are in your industry makes a difference. Local people tend to invest more in local companies,” he says. “We also incorporated new data that allowed us to measure political polarization of a company based on Facebook connections across counties, and other social connections.”
Taking stock of the gap
“First, we wanted to find out whether or not the returns of red and blue stocks behaved differently. Was there really a difference? What we found was very striking,” says Sheng. “They really were two different animals. In the face of COVID news, the red stocks had higher returns than those tied to blue stocks. It was a pretty amazing gap—as much as 20 basis points daily.”
Their data also provided insight into the risk attitude of different communities. “If people don’t feel safe, they are less likely to visit public places, and vice versa. With our data we were able to measure local risk attitudes for both red and blue counties and found that people in red counties are less likely to exercise social distancing in response to COVID cases and lockdown orders,” says Sheng. “This was the main driver, we found. About 40% of the gap was driven by political beliefs about COVID.”
Accounting for the StockTwits gap
Another surprising result was uncovered when the team began looking at the partisan disagreement measure based on StockTwits data made available by researchers Cookson, Engelberg, and Mullins. StockTwits is a social network platform on which investors can tweet about their opinions toward different stocks. “On days with high disagreement between red and blue investors, we noticed the most pronounced gaps, and a larger fluctuation in the market that corresponded directly to that,” says Sun.
Sun was also surprised at the magnitude of the returns gap and what it said about how students are traditionally taught to valuate companies. “What we teach in our classrooms about how to measure valuation—future cash flows, company risk, and so on—may need to change.”
“Our paper demonstrates that these old methods are not sufficient. For example, if you measured future cash flows of red and blue companies during the pandemic, they would be very similar. The same can be said for the risk factors of those firms, and we incorporated those into our study, but those traditional methods did not reflect the results we found,” she says. “If we don’t adjust our valuation methods to include the political polarization factors, we’ll be missing a very large part of the data and our valuations will continue to be wrong.”
Thanks to this ground-breaking study, we now have a better idea of how investors should evaluate the companies they invest in. “If we could get better data about the political affiliation of the investors,” says Sun, “we might find an even stronger connections to the performance of that company in the market.”
Building politics into our investing future
As the political divide in our nation continues to widen, it’s clear that partisanship is here to stay. Like it or not, investors need to seriously consider how this political polarization might impact their investments and respond accordingly.
“In the future, new disagreements along party lines are inevitably going to occur,” says Sun. “We need to learn to pay attention to how these may affect returns.” Sheng concurs, adding, “With COVID we can see how politics impact stock fluctuations dramatically, and we need to consider this, or we will suffer as a result.”
It’s not an exaggeration to say that politics now seriously impacts stock performance. If so, shouldn’t political affiliation inform our investment decisions?
No matter how—or if—you vote, your financial future may depend on whether you invest in red or blue companies from this day forward.
Jinfei Sheng is assistant professor of finance at The UCI Paul Merage School of Business. His primary research fields are empirical asset pricing, investments and behavioral finance. His papers use big data, machine learning, and textual analysis to tackle fundamental questions in finance and economics. A central theme of his research is to understand the roles of information in financial markets. He received his PhD in finance from the University of British Columbia.
Zheng Sun is associate professor of finance at The UCI Paul Merage School of Business. Her primary research interests are empirical investments, institutional investors, mutual funds, hedge funds, bonds and loans. She received her PhD from the Stern School of Business at New York University.
Wanyi Wang is a doctoral candidate at The UCI Paul Merage School of Business. Her main research interests are behavioral finance, FinTech and the application of textual analysis in finance. Her working papers explore the asset pricing implication of partisanship during the pandemic and investigate the role of technology in cryptocurrency pricing. She holds a Master of Economics from Peking University.