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What does divided government mean for the market?

Annie Lowrey* looks at the evidence (emphasis mine):

Stovall studied the performance of the S&P 500 from 1900 until this year under three scenarios: total unity (one party controlling the House, Senate and White House), partial gridlock (one party controlling both houses of Congress and the other controlling the White House), and total gridlock (a divided Congress).

Over all years, the S&P rose at a 6.8 percent annual pace. During times of total unity, 67 of the 111 years analyzed, it gained 7.6 percent annual pace. During times of partial gridlock, accounting for 32 years, they gained 6.8 percent. And during the 12 years of a gridlocked Congress, the S&P gained just 2 percent per year. Looking at more recent years, since 1945, the pattern holds. Under total unity, stocks climbed at a 10.7 percent annual pace. Under partial gridlock, they gained 7.6 percent per year. And under total gridlock, which accounts for eight of the 65 years, they gained just 3.5 percent per year.[...]

But Stovall only looked at the S&P 500. What about the market as a whole? Scott Beyer of the University of Wisconsin-Oshkosh, Gerald Jensen of Northern Illinois University and Robert Johnson of the CFA Institute examined broader market returns in a 2004 article for the Journal of Portfolio Management.

Like Stovall, they found that big-company stocks suffer during times of gridlock — returning 0.8 percentage points less than during times of unified government. But gridlock really hurts small stocks — the equity of little companies with less ability to adapt. During times of unity, they returned an annualized 23.5 percent. During times of gridlock, they returned 11.4 percent per year.

She also notes that polls of market participants show they want Republicans and Democrats to "cooperate" going forward. It's a good reminder "that 'the markets' are in reality 22-27 year old business school graduates," and their take on politics is no more or less prescient than you'd expect from that profile. Like most voters, they get excited when elections come around, as they overestimate the likelihood that the politicians they support will not just make major changes, but make the specific changes that they (in this case, "the market"), as opposed to the base, or the politician's favored special interests, want. Then some time passes and that hope is proven false and they settle into a period that's not just politics-as-usual, but the sort of politics-as-usual where nothing gets done.

By Ezra Klein  | November 1, 2010; 12:42 PM ET
Categories:  2010 Midterms  
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Comments

This feels a bit weak. There's almost certainly a causation/correlation issue going on here. To be convincing, I think the the data would need to be parsed a bit more. For example, it'd be useful to know the growth rate of the market during the years leading into a unified or totally gridlocked government. Also useful would be evidence that a unified government clearly turns an anemic market into a growing one during that government's rule. But as presented, this just feel like more evidence that ruling parties get rewarded (stay unified) or punished (get fully or partially ousted) based on the state of the economy.

Posted by: lukegmarshall | November 1, 2010 1:33 PM | Report abuse

I think quite a bit of the data is explained by timing and the economy. Did this guy control for the state of the economy?

Take 2001/2002. We had total gridlock (in theory), as Jim Jeffords blocked Republican control of the Senate. Stocks fell during both of those years. Was it Jeffords' fault? Would returns had been better had he remained a Republican?

Then in 2003 Republicans have control over both houses and the Presidency, and stocks soar. Was it because that, phew, there would be no confusion over the political agenda? Or after three long hard years, investors were finally over the scandals and the tech wreck?

Or consider 2007/2008. We had partial gridlock, and stocks tanked. But would stocks have tanked had the government been all Democratic or all Republican? Well sure, there was a financial crisis. That crisis helped ensure Democratic control of the government in 2009, and sure enough there was a rally - but would the market have not rallied hard if John McCain had won?

Or consider the early 1990s. We had partial gridlock in the 1991/1992, also recession years which are bad for stocks. Clinton, helped into power by that recession, then saw a stock market rebound. Later, the partial gridlock of the late 1990s appeared very good (or more appropriately, not bad) for stocks.

Unified government saw another boost in the 1960s which saw decent stock market returns - was it unified control, or were the 1960s just, in general, a great period for the economy?

Posted by: justin84 | November 1, 2010 2:47 PM | Report abuse

EK wrote:

"Stovall studied the performance of the S&P 500 from 1900 until this year under three scenarios: total unity (one party controlling the House, Senate and White House), partial gridlock (one party controlling both houses of Congress and the other controlling the White House), and total gridlock (a divided Congress)."

Ezra, this is impossible. There has only been a S&P 500 since 1957, and before that there was a S&P 90, only since 1923. Before that, only the Dow.

How could you make a mistake like this?

Posted by: 54465446 | November 1, 2010 3:06 PM | Report abuse

EK wrote:

"She also notes that polls of market participants show they want Republicans and Democrats to "cooperate" going forward. It's a good reminder "that 'the markets' are in reality 22-27 year old business school graduates," and their take on politics is no more or less prescient than you'd expect from that profile"


Not only is the part about the 22-27 year olds not close to being true, it's not even in the article you cite! Where did you get THAT quote fron?

This is most errant column you've written in a long time.

Posted by: 54465446 | November 1, 2010 3:34 PM | Report abuse

Ezra:

Found the quote. Your juxtapositioning of the sentence with the one above made it sound like it came from Lowrey. We'll call that my bad.

It's actually from Paul Krugman, thank God no one who actually works in the markets.

"Most people don’t realize that “the markets” are in reality 22-27 year old business school graduates, furiously concocting chaotic trading strategies on excel sheets and reporting to bosses perhaps 5 years senior to them. In addition, they generally possess the mentality and probably intelligence of junior cycle secondary school students. Without knowladge of these basic facts, nothing about the markets makes any sense—and with knowladge, everything does."

You know my opinion of bomb throwers like Krugman and Baker already. The full text of the quote revels this is just another version of "see I'm a Nobel winner and a university professor emeritus, so no one can possibly be as smart as me".

Posted by: 54465446 | November 1, 2010 4:23 PM | Report abuse

Actually, the stock market has done best under Dem Presidents. The most dramatic, of course, is under Clinton: Close on 1/20/1993 was 3242 and close on 1/19/2001 was 10,588, a gain of over 225%. So far for Obama: 1/20/09 close was 7949. Today it is 11,125. GW Bush: 1/20/2001 was 10,588 and opened on 1/20/2009 at 8280. Be careful what you wish for.

For comparison, Reagan, the best Republican, opened at 951 and closed at 2239, a gain of 135%, and GHW Bush opened at 2235 and closed at 3256, a gain of 45%. Even Carter wasn't that bad, he opened at 959 and closed at 951. Nixon-Ford opened at 931 and closed at 959 (the lost years--20 pts in 12 years). Kennedy-Johnson opened at 631 and closed at 930, a gain of ~50%. Ike went from 288 to 634, an 80% gain.

Posted by: Mimikatz | November 1, 2010 4:41 PM | Report abuse

54465446,

It's actually a comment on a blog post by Kevin O'Rourke that Krugman linked to and approved of.

http://www.irisheconomy.ie/index.php/2010/10/28/what-do-markets-want/

In any case, there's not much there to recommend it.

Not many 22 year olds are B-school graduates (and typically, Wall Street B-school grads are north of 27 as well), and it's not as if the analysts are making all of the important trading decisions.

In my view, the market is disproportionally represented by computers hunting for arbitrage opportunities and seasoned investors with large portfolios such as Soros, Gross, Barton, Paulson. Of course, twenty somethings are involved too but major portfolio allocation decisions (buy/sell Irish debt, % of funds allocated to Irish debt if any, per the context of the blog post cited) aren't made by them, by and large.

"their take on politics is no more or less prescient than you'd expect from that profile. Like most voters, they get excited when elections come around, as they overestimate the likelihood that the politicians they support will not just make major changes, but make the specific changes that they (in this case, "the market"), as opposed to the base, or the politician's favored special interests, want."

Do you have support for this, or is this just some sweeping statement we are supposed to take at face value?

Odds are, the traders care far less about politics than you do. Political concerns are more marginal and focused (how does the risk of cap and trade impact the valuation of energy and tier 1 parts suppliers in your portfolio, what does FinReg mean for bank credit risk).

In addition, I highly doubt that analysts who pitch trading ideas based on so-and-so's probability of being elected end up keeping their jobs for very long.

Posted by: justin84 | November 1, 2010 5:41 PM | Report abuse

justin:

Thanks, good to have you here again.

I know that Krugman didn't actually write it, but he quoted and endorsed it:

"That’s what I call a policy recommendation — and it’s better than most of what passes for wisdom these days."

and it drips with the "I'm smarter than you" sarcasm that so many university economists are known for.

I was actually more interested in Lowrey's quoting of Stovall on his impossible figures. I didn't bother to look it up to see if she was misreading what he said. My guess is that he was actually using the Dow, as would be common. Hard to understand how they could get this so wrong.

.

Posted by: 54465446 | November 1, 2010 6:34 PM | Report abuse

"Thanks, good to have you here again.

I know that Krugman didn't actually write it, but he quoted and endorsed it:"

54465446,

Krugman did quote and endorse it, but I think it's important to point out the source of Ezra's quote was 'ObsessiveMathsFreak' on an Irish economics professor's blog.

"I was actually more interested in Lowrey's quoting of Stovall on his impossible figures. I didn't bother to look it up to see if she was misreading what he said. My guess is that he was actually using the Dow, as would be common. Hard to understand how they could get this so wrong."

He might have used this data source (it is where I go when I need long term data for equities). Any way you slice it, it wasn't solely the S&P 500.

http://www.econ.yale.edu/~shiller/data.htm

Posted by: justin84 | November 2, 2010 9:01 AM | Report abuse

justin:

Thanks again.

If Ezra feels comfortable writing about the non-existent S&P 500 in 1900, then I'm pretty comfortable with my use of Krugman's article. LOL

Seriously though, I know what Stovall did was use hisotrical data to construct his own representative index of stocks from those years. To me though, that's like trying to create pre-election polling data on the 1900 election and then interpreting it. It simply lacks historical validity. See you on the next thread.

Posted by: 54465446 | November 2, 2010 10:45 AM | Report abuse

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