History shows that investors would be well advised to ignore presidential politics in their election-year investment strategizing. This time could be different.
Typically, actions of the Federal Reserve, in terms of easier or tighter money, are far more relevant to investors in a presidential election year than whether a Democrat or a Republican wins the White House.
But the surprise results of Thursday’s Iowa caucuses, handily won by Democrat Barack Obama and Republican Mike Huckabee, helped throw the stock market into a tizzy Friday. The likely outcome of Tuesday’s New Hampshire primaries, where Obama and Republican John McCain are favored, is unlikely to settle market jitters.
“Everything is going wrong. Let’s start with that,” said veteran market observer Byron Wien, chief investment strategist at Pequot Capital Management.
Housing and credit market woes seem to be getting worse as the new year begins. Corporate profits in the fourth quarter and probably in the first half of 2008 are expected to be broadly disappointing.
And voters seem to prefer candidates with little or no affinity for Wall Street or, for that matter, for the status quo.
“One of the things that is happening right now is that the Iowa caucus results threw a curveball to the market,” said Robert Johnson, executive vice president of the CFA Institute, a professional organization of investment managers.
With the unexpected results and strong voter turnout, the opening bell of the election year simply piled more doubts onto investors already weighed down by troubles. This stew is likely to simmer for a while.
In the summer of 2004, when pundits were blaming stock market gloom on the prospect President Bush would lose his bid for a second term to John Kerry, Johnson, along with Northern Illinois University finance professors Gerald Jensen and Scott Beyer, published a study titled “Don’t Worry About the Election, Just Watch the Fed.”
Their research exploded several myths, such as the notion that the stock market prefers Republicans in the White House and the idea that Wall Street likes political gridlock, defined as one party controlling the executive branch and the other controlling Congress.
In fact, they found that Federal Reserve monetary policy held the most powerful correlation to stock market swings. Easy money is good for stocks; tight money is bad. More recent research by the three scholars suggests the Fed tends to be especially friendly in the third year of a four-year presidential term.
“In the third year of a presidential cycle, the stock market tends to do extremely well,” Jensen said.
But last year was an exception to the rule, as the Fed easing cycle began late in the year. It takes months for lower interest rates engineered by the Fed to stimulate the economy. Inflationary warnings in oil prices and elsewhere threatened to curtail further Fed easing. Meanwhile, financial innovations banks have used in recent years to multiply available credit have been virtually shut down, Jensen said.
Given the exceptionally uncertain outlook for the Fed, politics might influence the stock market more than historical statistics would suggest.
Stock prices tend to slip in the first four months of an election year when the White House changes parties, according to the Stock Trader’s Alamanc. But this time, Wall Street is in an especially foul mood at the start of the first election year in decades without an incumbent president or vice president in the race.
“This is about as uncertain an environment I can remember in doing this research,” Johnson said.
“If I’m right, and there’s a landslide Democratic victory, that’s not good for Wall Street, because certainly the Bush tax cuts will be rolled back,” said Wien. “You can count on that, or at least I can count on that.”
The Obama surge versus Sen. Hillary Clinton is especially worrisome, he said. “I think the budget deficits will increase. There will be a number of [spending] initiatives. It’s fair to say that Obama will be more fiscally aggressive than Hillary would be. So, I think that’s not good for Wall Street.”
On the other hand, the Republican field is hardly calming jitters.
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“The Republicans are in turmoil,” Wien said “Huckabee, who’s probably not going to be the candidate, won in Iowa. John McCain, who’s probably not going to be the candidate, is going to win in New Hampshire.”
In short, the party that most investors believe, however incorrectly, is better for them is in disarray, Wien said.
Politics are compounding overall market angst, but it’s too soon to become overly obsessive about the contribution of the November election to stock market sentiment.
“Wall Street will have so many problems during the course of the year, that by November things could be turning around for other reasons,” said Wien.
The results of two stock market sectors closely tied to public policy have shown mixed results since the Obama bombshell in Iowa. Health-care stocks, which were the worst-performing sector in 1992, when Democrat Bill Clinton ousted Republican President George H.W. Bush, have been a safe haven in the recent slump. On the other hand, shares of big defense contractors, such as Chicago-based Boeing, have lost ground, as you might expect in an Obama presidency.
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Elections and the market
With the exception of 2000, markets have performed well in the last eight months of election years in which the incumbent party lost the White House. The market typically declines in the first four months of an election year.
1976
Winner: J. Carter
Loser: G. Ford
S&P 500 PERFORMANCE
First 4 months: +12.7%
Last 8 months: +5.7%
1980
Winner: R. Reagan
Loser: J. Carter
S&P 500 PERFORMANCE
First 4 months: -1.5%
Last 8 months: +27.7%
1992
Winner: B. Clinton
Loser: G.H.W. Bush
S&P 500 PERFORMANCE
First 4 months: -0.5%
Last 8 months: +5.0%
2000
Winner: G.W. Bush
Loser: Al Gore
S&P 500 PERFORMANCE
First 4 months: -1.1%
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Last 8 months: -9.1%
Source: Stock Trader?s Almanac, 2008
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