New governance and the transitional phase of political change is a notoriously volatile period for stock markets, characterized by large fluctuations in daily index values amidst an uncertain economic outlook. Such patterns between nation-state governance and stock market returns have been well documented by financial economists over the course of time, leading to the development of the presidential election cycle theory by Yale Hirsch in the 1960s. Taiwan serves as a compelling case study of the dynamic interplay between political transition and stock markets, which I argue is influenced greatly by psychological and emotional factors.
Since the first democratic presidential elections held in 1996, Taiwan has witnessed two new leaders come to power, Chen Shui-bian (Democratic Progressive Party, 2000-2008) and Ma Ying-jeou (Kuomintang, 2008-present). Kuomintang leader Lee Teng-hui (1988-2000), who was handed presidency following the death of Chiang Ching-kuo in 1988, won the first democratic elections on March 23, 1996. Both Chen and Ma were re-elected for consecutive terms, which expire after four years.
Historical data of daily closing prices under the Taiwan Stock Exchange Capitalization (TAIEX) Weighted Stock Index reveals strong parallelisms between the stock markets and presidential election years. Chen and Ma’s rise to power were the two most volatile trading years in Taiwanese democratic presidential election history, recording 40 and 42 days of “volatile trading” in 2000 and 2008, respectively. Moreover, the transition towards new governance also resulted in the highest annual losses of the TAIEX over the same time period from 1996-2014, finishing the year down 45.9% (2000) and 44.8% (2008).
Were the government’s targeted strategic industries more vulnerable to the uncertainty of election outcomes? This appears to be the case, according to cross-analyses of industrial group stock indexes during years of presidential elections. Strategic industries such as semiconductors, electronics, and information technology exhibited greater losses during election years, providing evidence in support of this argument. For example, the electronics industry was weathered badly by the political storm in both 2000 (-52.3%) and 2008 (-48.9%), while the food industry fell by -26.7% and -24.0% over the same time frame.
Still, these patterns of volatility and annual stock losses during Taiwan’s transitional phase fail to shed light on the psychological behavior of investors during presidential election cycles. It could be argued that investors acted as entirely rational agents who took into consideration the uncertainty of the economic outlook, and thereby refrained from speculating on sensitive stocks such as photovoltaic enterprises that rely heavily on government subsidies. This explains one part of the puzzle.
The more intriguing puzzle that ought to be understood is why government-independent industries such as food and retail fell significantly in 2000, despite the expansion of the domestic economy that year. Intuitively, we would expect new governance to have very little effect on the intrinsic value of individual food stocks or projections of future growth for the industry. In reality, it could be argued that uncertainty over the direction of new governance led to the development of low Keynesian animal spirits, which decreased investor confidence. This uncertainty and pessimism was magnified further by the “consumer multiplier” effect, causing stock declines across all industries.
Until now, we have only considered the post-democratic era of Taiwanese presidential election history, which spans barely three decades. It is of equal interest to explore the movements of financial markets since the TAIEX started operating in 1967, when the National Assembly was responsible for electing leaders. In particular, one political event worth highlighting is the passing of Chiang Kai-shek in 1975, one of the most influential leaders in the nation’s history.
In the years leading up to Chiang’s death, the stock markets were relatively stable, making small but steady annual gains. Chiang’s death on April 5 signaled a wave of volatility for the Taiwanese stock market, though its effects were not evident in the immediate days following his death. The subsequent months told an entirely different story - in June alone the TAIEX faced 11 days of volatile trading, reflecting doubts and lack of investor confidence in the new political phase of governance.
Had the markets been anticipating grave news concerning their leader, having some knowledge of Chiang’s health scares in the months prior to his death? This might explain the delay in response of the financial markets to news of Chiang’s passing. More intriguingly, the TAIEX ended the year up 73.0% - a stark contrast from the huge declines experienced when Chen and Ma took power. Again, we return to behavioral economics to try comprehend the narrative behind the 1975 stock rally. Chiang had been in power for 47 years, and his reputation was divided amongst the Taiwanese population. For those who regarded him as an oppressive dictator, the occasion gave rise to a renewed sense of optimism, inspiring a positive outlook for the economy and financial markets.
On a closing note, it should be stated that the financial shocks resulting from new governance in Taiwanese history were transient in nature, with no long-term consequences on the trajectory of the stock markets. This brief case study of Taiwan demonstrates that financial markets are indeed closely intertied with developments in political governance, experiencing larger fluctuations in daily trading than non-election years. Bear in mind that Taiwan’s political history is relatively young, and thus we should not make larger generalizations on the basis of a few political events.
 I define “volatile trading” as daily fluctuations of at least 3% from the previous day’s closing value.
 A phenomenon described by George Akerlof and Robert Shiller. The consumer multiplier is analogous to that of the Keynesian multiplier effect, whereby consumer confidence propagates throughout the economy.
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