Election effect on the stock market

One possible effect of the election next Tuesday is that enough Democrats will be elected to take over one or both chambers of Congress. What's that likely to do to the stock market?
This would bring the government to a condition sometimes tagged "gridlock", where the government spending is severely hindered-- a spending spree by a Democrat congress would be vetoed by the Republican president, while spending proposed by the Republican president wouldn't make it into the congressional budget. Oddly, this is the best case scenario, as far as business is concerned:
The likely result would be legislative "gridlock," which historically has been bullish for stocks, notes Mark Riepe of the Schwab Center for Investment Research. His analysis of election years dating to 1953 shows that the average return of the Standard & Poor's 500 index was 14.1% per year in gridlock years, vs. a 10.4% gain when one party controlled the presidency and both chambers of Congress.
(from http://www.usatoday.com/money/markets/us/2006-10-26-winners-losers-usat_x.htm )
That's a 36% higher annual return for gridlock years-- not just bullish, but hugely bullish for the market.
"Faced with a Democratic majority in Congress, President Bush would utilize his veto pen a little more readily," says Jerry Webman, chief economist at Oppenheimer Funds.
The USA TODAY "Small Business" columnist notes: "A balance of power in D.C. would help small businesses" http://www.usatoday.com/money/smallbusiness/columnist/strauss/2006-10-30-balance_x.htm
"There is no doubt that the election of 2006 will have some fairly profound effects on the business landscape.
"The first is that because it seems likely today that the Democrats will take back the House, we will once again have divided government. I recall during the 1990s, when Democrats controlled the executive branch and Republicans controlled the legislative branch, that there was much talk of "gridlock" in Washington. But do you know what? Gridlock was not so bad. Too much power in one party, whatever the party, seems to poorly serve both that party and the country.
"So, ironically, with gridlock poised for a comeback, legislative change is in the air. The beauty of divided government is that both parties are forced to compromise to get anything done, and that alone is usually good for all of us."
So, if the Democrats win, the most likely case is to expect government spending to go down, and expect the economy to go up.
-- Franklin Jefferson ***My blog: Jefferson's Democracy*** http://franklinjefferson.blogspot.com
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"1. Lengthy posts, cross posts, copyrighted material, articles and political comments should be directed elsewhere. And except in flattering terms, reference to another poster or group of people is discouraged."
The OP had one goal in mind when he posted and it had nothing to do with financial planning. It had to do with telling us how to vote. If that's not political I'll eat YOUR hat.
Elizabeth Richardson
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Elizabeth Richardson wrote:

If only the OP had stopped at telling us, simply, to VOTE... <sigh>
-Mark Bole
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Mark Bole wrote:

*That* would have been off topic.
However, that's good instructions. VOTE.
-- Franklin Jefferson ***My blog: Jefferson's Democracy*** http://franklinjefferson.blogspot.com
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Elizabeth Richardson wrote:

Are you a moderator?
Best regards, Bob
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Franklin Jefferson wrote:

I don't know why that Schwab guy would get credit for the idea that gridlock is good for the stock market, I remember reading that at least 10 years ago. It makes some sense, kind of, but I don't think it's worth spending time attempting to predict this kind of thing -- nothing is particularly "likely" even assuming we know who's going to win, which we don't.
As an example you could say that perhaps a Dem-controlled Congress will clamp down on government-sponsored entities Fannie Mae & Freddie Mac, to such an extent that it leads to a big constraint on lending and a rapid collapse of housing prices, defaults on the loan portfolio, Armageddon, and adoption of the Loonie as our new currency.
Or not...maybe they won't do that, and maybe there won't be any effect even if they do.
There are literally hundreds of these "what if?" narratives around election issues and the market is far too complex to say with any likelihood how it will all net out. Makes for blog material though, I guess.
-Tad
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Tad Borek wrote:

Oh, there's nothing new about predicting that gridlock is good for the market. Anybody could do that, in fact, I've done so myself. Predictions, in the absence of data, are not interesting.
What is valuable is that the analyst (Mark W. Riepe; published in Journal of Financial Planning, August 2004) analyzed the actual data from 1953 through 2004, comparing gridlock to non-gridlock years. Years in which a single party controlled the legislative and executive branches had an average return to the overall market of 10.67 percent. For the gridlock years, the average return was +14.08 percent.
This is not a Democrat-vs-Republican thing. When a Democrat president had a Republican Congress, the market outperformed times with Democrat president and Democrat congress. When a Republican president had a Democrat Congress, the market outperformed Republican president with Republican Congress. It's the opposition effect-- gridlock-- not the party affiliation.
Of course this could be chance. That's 50 years of data, but fifty years is really not that long a data series; the market has cycles that are longer than that. Still, it's very provocative data.
Sorry if you think that's "politics", not "analysis." If you'd like to try your own analysis of the data, I would be interested in seeing the result.

-- Franklin Jefferson ***My blog: Jefferson's Democracy*** http://franklinjefferson.blogspot.com
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Franklin Jefferson wrote:

What's more significant to me is this; the JFP article
http://www.fpanet.org/journal/articles/2004_Issues/jfp0804-art2.cfm (I'll spare the group's need to use "the Google")
concludes, "When we take these factors into account, [the use of few data points with data of such high standard deviation] the best we can say is that there's a 52 percent chance the difference in return we see is real as opposed to being a random occurrence." Why do you come to a different conclusion than the source article you cite? (also I removed the crosspost - surprised that slipped through) JOE JoeTaxpayer.com
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On Sat, 4 Nov 2006 07:47:53 -0600, joetaxpayer

Thanks. That one got by me.
-HW "Skip" Weldon Columbia, SC
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I can reproduce the difference in stock market return conclusion (it's just a matter of averaging), but when I do the statistics, I can't reproduce conclusion that the result is statisticaly insignificant.
For one thing, any time somebody phrases a statistical test in terms of the chance that the result is real, this is a flag that they're a little fuzzy about statistics-- in fact, a statistical test can never answers that question. It only answers a slightly different question, "what is the probability that this result could have been achieved by chance?"
So, let's do the statistics. The hypothesis is: "The stock market performs better in years when the government is gridlocked." This is a plausible a-prior hypothesis; I've heard many people suggest that the economy does better if the government is gridlocked. The null hypothesis is thus: "The stock market does not perform better in years when the government is gridlocked.:
So, the statistical test needs to answer the question, given the standard deviations measured, what is the probability that the null hypothesis would reproduce the difference in performance? Now, for the data:
Gridlocked years: Xave(g).08%, N2, sigma.46, sigma/SQRT(N)=3.09 Non-gridlocked years: Xave(n).67%, N, sigma.55, sigma/SQRT(N)=4.36
So, in fact, the averages of the distribution are just around one sigma apart. The rule of thumb is going to say that this is right at the edge of significance, but to get real numbers, this is a job for Student's t test. Skipping details (wikipedia has a decent article if you want details; http://en.wikipedia.org/wiki/Student%27s_t-test ), I calculate a t value of 0.67. Flipping to a table of the t-distribution, degrees of freedom = 49, t=0.67 comes out at just about 76%
So, there's a one in four chance that this result would have come out of a random distribution. Is 76% significant? Your call. It would take another 150 years of data (assuming no change in the averages, or in sigma) to bump this up to 85%, so this is pretty much as good data as you're going to get, in this lifetime.
joetaxpayer wrote:

-- Franklin Jefferson ***My blog: Jefferson's Democracy*** http://franklinjefferson.blogspot.com
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<snip>

Government spending will not go down regardless of which party is in power. The last time Federal Government spending went down was 1965. Spending dipped to 118.2 billion from 118.5 billion in 1964. Federal spending has gone up every year since 1965 and there is no rational reason to expect something different in the future. Plan accordingly.
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Franklin Jefferson wrote:

<snip>
A recent paper comes to a different conclusion.
http://www.cfapubs.org/doi/abs/10.2469/faj.v62.n5.4280 Gridlock's Gone, Now What? Financial Analysts Journal Scott B. Beyer, CFA, Gerald R. Jensen, CFA, and Robert R. Johnson, CFA September/October 2006, Vol. 62, No. 5: 21-28 Abstract This article examines the relationship between security returns and "political gridlock," which occurs when the U.S. House of Representatives, Senate, and presidency are not controlled by the same political party. The findings support the following conclusions: First, the common view that equities prosper during political gridlock is a myth. Second, fixed-income securities do prosper during gridlock. Third, large companies exhibit higher returns than small companies during gridlock. Finally, the relationship between gridlock and security returns is independent of monetary conditions; this finding supports the existence of a unique "gridlock effect." Overall, political conditions are relevant for investors, but previous views about their influence are misguided.
Another recent paper finds that stock returns are lower and more volatile when Congress is in session.
http://papers.ssrn.com/sol3/papers.cfm?abstract_idh7211 Congress and the Stock Market MICHAEL F. FERGUSON University of Cincinnati - Department of Finance - Real Estate HUGH DOUGLAS WITTE University of Missouri at Columbia - Department of Finance March 13, 2006 Abstract: We find a strong link between Congressional activity and stock market returns that persists even after controlling for known daily return anomalies. Stock returns are lower and volatility is higher when Congress is in session. This "Congressional Effect" can be quite large - more than 90% of the capital gains over the life of the DJIA have come on days when Congress is out of session. The Effect varies systematically with the public's opinion of Congress: returns are lower and volatility higher when a relatively unpopular Congress is active. Public opinion appears to play a fundamental role in market prices. This is consistent with a mood-based explanation that sees Congress as 'depressing' the average investor. Alternatively, our results can also be reconciled with rational explanations that view Congressional activity as a proxy for regulatory uncertainty or rent-seeking behavior. Keywords: stock market, Congress, anomalies, behavioral finance JEL Classifications: G1, G10, G14, G18
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I wont weep if the "Clinton golden age" returned. The stock market increased like 450% those 8 years. Better than Reagan or the Bushes.
In the short term mid-term elections are generally positive and the following years not as good.
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I will. Many people lost all sense in the latter part of those years and became nothing more than gamblers and numerologists. With the corrections of 2000-2001, the less educated became cynical about investing in stocks altogether.
Individuals need to study the long term when considering investing in stocks.

Barely.
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Clinton up 450%. Reagan up 250%. Bush H. up 50%. Bush W. down 20%.
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So, you don't think the 2001-03 bear is due to the irrational exuberance of the Clinton era? Most would. We were on or way to a recession before he left office.
Elizabeth Richardson
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Elizabeth Richardson wrote:

I think there's a fundamental flaw in all of this -- assuming that who's in office has that much to do with how the economy does, or how the stock market performs. It's a factor but to me a very small one. As much as the Clinton administration might want credit for that bull market, or W might want credit for 2003's huge returns, I don't think the executive branch was much of a factor in either. And not because it was just creditable to a predecessor administration (e.g. the Reaganite's "peace dividend" argument for the 90's bull market). It's just so much more complicated than "who was in office?"
To me that's the huge flaw of the original "gridlock" premise, it ignores the time separation between policies and outcomes. The study is looking at alignment between Congress & prez, and the concurrent stock market returns. Even assuming that federal legislation could have these kinds of overwhelming effects on our huge economy & stock market, isn't it likely these effects will show up only much later? Sure some things could be priced by the market quickly ("Canada imposes new tax scheme on royalty trusts"). But for most, it could take years for the effects to materialize. And by then who could sort out what the real cause was? Nixon decided to open up relations with China, 30 years later we have Wal-mart. Should we credit Wal-mart's growth to those years? Or do you just look at whether the stock market went up that year and assume that built into stock values were accurately predictions about Wal-mart's rise years later? It's kind of an absurd premise.
I think it's silly to look at the elections and predict what might happen to the economy or market or worse, change financial plans based on that. I see this all as "data mining" on par with the Super Bowl Indicator. Thank goodness politicians don't have that kind of effect on the market! But in a way they do, if you bother to change your plans because of election hype.
-Tad
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Shiller S&P 500 data: Reagan-Bush, 1981-1992 = factor of 3.12 increase Clinton, 1993-2000 = factor of 3.42 increase
In 2000, Clinton's final year of office, the NASDAQ crashed from 4000 to 2500. I do not write all this as a criticism of Mr. Clinton or any of the recent Presidents. Instead, it's to point out that IMO you are making a distinction without a difference. After all, the so-called "Clinton golden-age" is also known as the age of "irrational exuberance." Having voted for Mr. Clinton twice, I hope my comments above might be viewed as an attempt to be honest, rather than plug a political party. If you want to talk problems with budget deficits or national debt, then that's something we might hang on a President and/or Congress. But when it comes to the stock market, most of the blame or credit belongs to investors, AFAIC.
Folks should contemplate long-term trends, and not invest based on short-term guesses re Congress or the Presidency.
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