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    Politics Flunks Test as Stock-Market Predictor: Caroline Baum

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    Politics Flunks Test as Stock-Market Predictor: Caroline Baum

    Post by sang_garuda on Fri Oct 31, 2008 6:47 pm

    The 2008 presidential election campaign is coming to a close, and for most Americans, it's good riddance. We won't miss you when you're gone.

    Whether financial markets will be happy with the outcome is a different matter.

    Everything points to a Democratic sweep of the executive and legislative branches on Nov. 4. So why isn't the U.S. stock market euphoric instead of wallowing near five-year lows?

    According to the New York Times, which ran the numbers and a graphic on Oct. 14, the Standard & Poor's 500 Index has outperformed under a Democratic administration, with average annual returns of 8.9 percent compared with 0.4 percent under the GOP. Even excluding Herbert Hoover, the Dems win hands down.

    Aside from being counterintuitive -- the GOP is the party of big business -- the perceived relationship between the president's party and the stock market is ``meaningless,'' according to Harvard University economics professor Greg Mankiw.

    In a recent post on his blog, Mankiw says that if the stock market is the efficient discounting mechanism it's touted to be, prices should incorporate all the information ``on Election Day, or maybe even during the days leading up to the election'' when it becomes clear a Democrat is headed for the White House.

    For those who eschew the efficient markets hypothesis in favor of the roll-the-dice/stock-market-as-casino model, Mankiw offers a counterargument. If markets don't anticipate events but instead react to them, why is the market's performance from the first to the final day of a presidential term the relevant period?

    Divided We Stand

    ``Policy influences the economy with long and variable lags,'' Mankiw writes. ``Trying to isolate the difference between the parties using this kind of stock-market data is silly at best.''

    Besides, the president isn't the only one making policy. The U.S. Congress, especially with a filibuster-proof majority in the Senate, has a hand in the process.

    For those who like their statistics absolute, the make-up of Congress is even more important than the president's affiliation, according to Jeffrey Hirsch, editor in chief of the Stock Trader's Almanac.

    ``Republican Congresses since 1949 have yielded an average 16.8 percent gain in the Dow compared with a 6.7 percent return when Democrats have controlled the Hill,'' Hirsh says.

    This may be meaningless, too, for the same reasons Mankiw cites.

    What does make some sense, at least intuitively, is the composition of government -- whether it's divided or unified under a single party -- should carry more weight than the affiliation of the president and congressional majority.

    Go for Gridlock

    For their tax dollars, Americans prefer gridlock, which is another way of saying they like their government to have a built- in system of checks and balances, with each party canceling out the worst intentions of the other.

    Hirsch's data support the idea that gridlock is best for the stock market, with a Democratic president and GOP Congress yielding the maximal results: an average gain in the Dow Jones Industrial Average of 19.5 percent.

    Of course, those results are based on only three observations (each two-year congressional term counts as one) -- and one big stock market bubble. From 1995 through 2000, Bill Clinton was in the White House, the GOP ran Congress, the stock market was on the moon and the bubble burst early in George W. Bush's watch. An ``ex-bubble'' adjustment would produce different results.

    Outgoing President's Revenge

    There's one more element, albeit unseen, that should be considered in an attempt to tie stock-market performance to politics. And that's the pace and cost of regulatory initiatives.

    Jim Bianco, president of Bianco Research in Chicago, has long used the number of pages in the Federal Register, the government's daily rule book, as a proxy for the regulatory burden imposed on the economy and the markets.

    To the extent that divided government curtails the growth in regulatory activity, it's better for bond and stock markets than one-party control, Bianco says.

    And one more thing: Lame-duck presidents ceding the White House to the other party don't go quietly into the night, according to a study by Veronique de Rugy, a senior research fellow at the Mercatus Center, a free-market think tank affiliated with George Mason University in Arlington, Virginia. Rather, they aim to leave their mark through a burst of ``midnight regulations.''

    In the last 60 years, the volume of regulation in the final three months of a presidential term is 17 percent higher on average when the president and his party are booted out of the White House, de Rugy finds. These last-minute executive orders, proclamations, administrative directives and regulatory documents are ``systematic and cross party lines,'' she says.

    Sitting Ducks

    Congress is hardly an innocent bystander.

    The more days Congress is in session in the month before Election Day, ``the more regulations will be promulgated,'' de Rugy says.

    Just to recap: The U.S. is looking at the prospect of a unified, all-Democratic government (one negative); a complete changing of the White House guard, auguring a burst of midnight regulation (second negative); and a Congress agitating for more regulation (third negative), not necessarily smarter or more effective oversight, to guard against a recurrence of the current crisis.

    That doesn't sound like a good combo for the stock market. Then again, if efficient-market theorists are correct, all the bad news is already reflected in the price.

    (Caroline Baum, author of ``Just What I Said,'' is a Bloomberg News columnist. The opinions expressed are her own.)


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