Mr. President And Mr. Market

By Aryeh Katz | March 08, 2010 AAA
Mr. President And Mr. Market

Was Barack Obama's ascension to the Oval office in November 2008 the catalyst that lifted capital markets out of their funk and subsequently spurred them to strong gains through 2009? No doubt, he and his supporters would have you believe so. Detractors, of course, would point to a very different set of reasons: the efforts of former Bush Treasury Secretary, Henry Paulson, and Fed Chairman Ben Bernanke, for instance.

But what is the truth? Does the stock market move predictably according to who controls the White House and Congress? And can government policy genuinely affect the fortunes of domestic and foreign bourses?

It's a question the academic world is asking, with a number of papers appearing recently, but whose conclusions are contradictory. (Find out how these two agencies create policies to stimulate the economy in tough economic times in The Treasury And The Federal Reserve.)

Long-Term Studies Dismiss the Connection
One comprehensive study, done for the prestigious Journal of Economics and Finance, took 104 years worth of monthly market returns and examined their relationship with U.S. election results. The verdict? Most factors which were not statistically significant and the ones that were have insignificant explanatory power. That is, there was no evidence that stock prices could be predicted based upon either which party controlled government, or in which years of the presidential cycle investors were situated.

There are some who find that particular political events can affect the market's performance, particularly when they create uncertainty. The event that garnered the most attention in this regard was the 2000 American presidential contest, for which results were delayed for over a month while the Supreme Court decided on the constitutionality of a ballot recount in Florida. (How can the presidential election affect your portfolio? Find out in The Market And Presidential Promises.)

The results of that delay were decidedly unfavorable for markets. In a piece published by that same Journal of Economics and Finance, researchers determined that not only were U.S. markets negatively affected by the delay, but Canadian and Mexican bourses were also negatively impacted. The "surprise" here was that Canada and Mexico, whose economies are tightly tied to America's, were measurably affected by a political occurrence rather than an economic one.

Markets Prefer Certainty
Researchers have noted that sell-offs in the market recur with measurable regularity in the months just prior to presidential elections, particularly in those years when it appears the incumbent will lose the race. Again it's the uncertainty in these cases that plagues investors.

The chart depicts the meaningful immediate impact that an incumbent's fate has on markets. But it should be stressed that this effect is only witnessed on a short-term time horizon. As mentioned, Barack Obama had the worst first 40 days in office of any president in the last 100 years, only to see gains of better than 20% on the S&P 500 for the full year that followed.

Is it impossible, then, to determine whether there exists any bona fide impact on markets from U.S. politics? (The Fed was created to study and implement monetary policy in the U.S. Learn how in The Federal Reserve: What Is The Fed?)

A Trader's Advantage
The results seem to point to genuine shorter term effects, which are subsequently subsumed by general market trends. That's good news for traders but for those investing for the long haul, it appears there's little advantage.

So how does one read the political landscape in a profitable way? The recent surprise electoral victory of Republican Senator Scott Brown of Massachusetts had many believing that the markets would rally strongly. After all, there would be less likelihood of Obama's health care proposals moving quickly through congress and less chance, in general, of bigger government initiatives becoming law.

Well, surprise, surprise. The following chart of the S&P 500 depicts trading for the month in which Brown was elected.

It clearly shows that the market responded in precisely the opposite fashion, falling consistently in the weeks following the election. Of course, traders were also contending with a potential default in Greece and speculation about the future of interest rates, to name just two factors, but who would have predicted a straight line down on such "good" news?

The Bottom Line
In short, if you're looking for a trading advantage from keeping abreast of American politics, it's there, but it won't be easy to discern. In fact, it might even be easier to go in the other direction and bet on who will win the next election based on the current state of the markets and economy. It's not often people vote for change when they're happy - and rich.

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