How Will the Change in Political Leadership Impact the Market? With the Presidential election over, speculation of how the electoral votes would add up has given way to debates on whether the multiple government-sponsored bailouts will be enough to rescue our faltering economy. The economic crisis will certainly be at the forefront of President Obama’s agenda as he begins his term; and it’s likely the pundits will persist with their predictions on how the new administration and a Democratic-controlled Congress will impact the market.

Conventional wisdom holds that D.C. gridlock – a Democratic President and Republican-controlled Congress or vice versa – is best for markets. The idea there is that neither party has the power to make the sweeping policy changes that can cause significant market gyrations. However, according to data compiled by the research firm Bespoke Investment Group in Harrison, N.Y., in the seven periods when Democrats had complete control of U.S. political power, the S&P 500 rose 14.7% on average while in the eight times a Republican served as President and Democrats controlled Congress, the benchmark index rose 7.4%. So much for conventional wisdom.

Interestingly, with the industry’s constant disclaimer that history cannot predict future performance as a backdrop, there are numerous recent studies that attempt to do just that and predict how the new administration and Congress will fare in dealing with our nation’s newly-declared recession and record budget deficit.

In his opinion piece, “Divided Government Is Best for the Market,” published in the Wall Street Journal on September 12, Donald l. Luskin begins his analysis of whether the economy historically has done better under Democrats or Republicans by stating, “There is no shortage of exaggerated claims on both sides.”

When the chief investment officer at Trend Macrolytics LLC ran the numbers, he found since 1948, the Standard & Poor's 500 total return (capital gains plus dividends) has averaged 15.6% when a Democrat was in the White House and only 11.1% when a Republican was in the White House. In terms of real gross domestic product, he found under Democratic presidents, the average since 1948 has been 4.2%. Under Republican presidents it has been only 2.8%.

However, moving beyond political labels, Luskin notes that not all Democrats act like Democrats, and not all Republicans act like Republicans. He writes, “John F. Kennedy, for example, was an enthusiastic supply-side tax cutter and George H.W. Bush raised taxes. Bill Clinton promoted free trade and Richard Nixon imposed wage and price controls.”

With that in mind, Luskin assigns those four presidents to the opposite party and finds numbers completely reverse themselves. That is, stocks average 14.7% under Republicans and only 10.5% under Democrats going back to 1948. In fact, he points out that just one switch – making Richard Nixon into a Democrat – is enough to reverse the numbers and have stocks averaging 14% under Republicans and only 12.1% under Democrats. Writes Luskin, “This fact discredits this whole study more than it does Republicans or even Richard Nixon himself. Any analysis that can be undone by omitting or changing a single data point isn't very robust.”

Of course, the President alone cannot determine the direction of the stock market or enact new taxes. Congress makes the laws. And, you guessed it, there are plenty of studies that look at market performance based on who’s in control on Capitol Hill. According to Luskin, under Republican Congresses, stocks have averaged a 19% return, while under Democratic Congresses only 11.9%.

Party politics aside, there’s ample analysis on how the market reacts when Americans go to the polls and when a new President takes office. For example, in the last 20 election years, not including 2008, there have been only two years where the S&P 500 Index had a negative return. In 1940, when Roosevelt faced Willkie, the S&P lost 9.8% and in the 2000 contest when Bush ran against Dukakis, the S&P lost 9.1%.

Further, Marshall D. Nickles’ “Presidential Elections and Stock Market Cycles” finds an initial post-inaugural slide is followed by strong performance. Investigating presidential election cycles from 1941 through 2000, he discovered stock market lows occurred surprisingly close to mid-year congressional elections or approximately two years before presidential elections.

Another study, “Mapping the Presidential Election Cycle in U.S. Stock Markets” by Wing-Keung Wong, National University of Singapore, and Michael McAleer, University of Western Australia, shows that in the almost four decades from January 1965 through December 2003, U.S. stock prices closely followed the four-year Presidential election cycle. Specifically, stock prices fell during the first half of a Presidency, reached a trough in the second year, rose during the second half of a Presidency, and reached a peak in the third or fourth year. In fact, the researchers showed this cyclical trend holds true for the greater part of the last ten administrations, from President Lyndon Johnson to President George W. Bush, particularly when the incumbent is a Republican.

Obviously, the large number of studies conducted on presidential cycles and the market’s fate under various parties proves the American public has an appetite for this kind of historical analysis. However, experts in the field of behavioral finance identify the harmful tendency to identify patterns and project them into the future as “oversimplification.” In fact, investors’ desire for control often leads them to identify patterns in purely random events. This ensuing false sense of reality more often than not leads them to embrace the false conclusion that they know which way the market is going. Bottom line? Sure, the studies and statistics are interesting, but the data should not impact your investment decisions.

Source: online.wsj.com

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Source: gbr.pepperdine.edu  8:06 AM •