Popping Political Myths

The truth behind legends of election year

Your Money

August 22, 2004|By BILL BARNHART

With the stock market in a funk, market analysts have turned to a different wager M-y Bush vs. Kerry.

Betting on who will win is under way through several Web sites.

The Iowa Electronic Markets, conducted by the University of Iowa, offers trading in futures contracts pegged to predictions of the vote split between the Republican and Democratic candidates.

In previous presidential elections, the Iowa Electronic Market has proven to be an accurate forecaster. Currently, the market shows a toss-up election, with Kerry gaining slightly.

Conservative commentators leaped on the results to blame Kerry for the recent decline in the stock market.

This sort of correlation presented as causation runs rampant in every election season. But aside from water-cooler conversation, simple statistics about the market and politics serve no useful purpose for investors.

Three researchers probed the most widely quoted theories about supposed political effects on financial markets.

Scott Beyer and Gerald Jensen, finance professors at Northern Illinois University, and Robert Johnson, head of the Charter Financial Analyst Institute in Virginia, found that the myths about politics and investing tell more about the shortcomings of statistical analysis than about investing or politics.

M-tToo often people try to come up with theories, and very simplistic ones, that explain the direction of the market,M-v Johnson said. M-tRemember the Super Bowl theory [that the stock market rallied in the year after an original team from the National Football Conference won the Super Bowl]? You can come up with correlations, but they can be spurious.M-v

Using data from 1937, Johnson outlined three popular beliefs about presidential politics and financial markets.

Bill Barnhart is a columnist for the Chicago Tribune, a Tribune Publishing newspaper.

CLAIM: Second half of presidential term better for markets

REALITY: Not always

One of the most widely quoted theories is the notion that the stock market does better in the final two years of a presidentM-Fs term, when the incumbent is stoking the economy in hopes of re-electing himself or his party.

M-tThat hasnM-Ft held [consistently] for 20 years,M-v Johnson said.

For example, the first year of George H.W. BushM-Fs term, 1989, was the best year of his presidency, as far as the benchmark Standard & PoorM-Fs 500 index was concerned.

The same was true in the second administration of Bill Clinton.

The S&P 500 soared 31 percent in 1997.

Few investors would say that the fourth year of the George W. Bush administration is a winner so far.

CLAIM: Wall Street thrives during political gridlock in D.C.

REALITY: Not true

The idea that investors benefit when the party in the White House and the party controlling Congress are different, thereby stifling political initiatives, is widely believed M-y and false.

M-tWhen you actually look at the evidence, itM-Fs at best neutral,M-v Johnson said. Indeed, he and his colleagues found that small-cap stocks do better when party unity reigns between Congress and the White House.

Oddly, returns on Treasury bills M-y a proxy for inflation M-y appear to be higher during periods of gridlock than periods of non-gridlock.

ThatM-Fs contrary to the notion that political unity leads to inflationary federal spending.

CLAIM: Stocks do better under Democrats than Republicans

REALITY: True, but...

The pundits currently juxtaposing KerryM-Fs gain in the Iowa futures market against the decline in the stock market apparently missed this hypothesis, which is actually true.

But Johnson says the statistics are misleading, because they fail to consider a far more dominant influence from Washington M-y the behavior of the Federal Reserve.

Since the 1950s, when the Fed became actively engaged in micromanaging the economy through its interest rate policies, easy credit vs. tight credit has explained much more about investment returns than party politics.

Since the start of the Nixon administration, the gain by the S&P 500 for Republican presidents (not counting the current administration) during periods of easy-money conditions has been more than 25 percent on average.

The average gain for Democrats presiding during expansive credit periods has been 15 percent.

During periods of tight monetary conditions, Democratic presidents have enjoyed S&P 500 returns of 13 percent, while Republican presidents suffered a loss of 5 percent.

Given the fact that the Fed is on a campaign to tighten credit, investors might be better off with a Democrat as president, according to this data.

But this conclusion and others are probably unwarranted, in part because of the small sample size of presidential administrations since before World War II, Johnson said.

M-tI certainly think it matters who wins the election,M-v Johnson said. M-tVoters and investors should be concerned with the policies of the candidates.

M-tBut what we are saying is there is no systematic, significant relationship between the political party of the president and capital market returns.M-v

On the other hand, M-tWe are still amazed about how strong the monetary policy influence is,M-v he said.

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