Sunday, August 22, 2010

Gridlock is Great for Stock Market Returns

"Since 1973, using the price of gold as a deflator (instead of the Consumer Price Index, which has suffered from style drift over the years) real, inflation-adjusted returns for the S&P 500 were a fabulous 15.3 percent gain in “gridlock” years, and a horrible 9.9 percent loss in years with unified government (see chart above). That’s a 25 percentage point difference.

The reason for this difference is simple: Unified governments spend far more, and more quickly, and expand regulation much more than split governments do. Programs sail through, the dollar is jeopardized, and investors seek real assets like gold to counteract the political risks of an activist government.

Based on the data, the ill effects of unified government apply to both Republican (a 7.7 percent loss) and Democrat (a loss of 11.5 percent) unified governments. The best was a split between a Republican Congress and Democratic President Clinton, which produced a whopping 32.8 percent real return.

President Reagan and a split Congress did pretty well too, with a 24.8 percent real return. Both President Reagan and Clinton did their best sustained work with a constraining Congress, or, to be more accurate, those Congresses did their best work with popular Presidents.

When it comes to split government and real returns, the right answer is “divided we stand, united we fall.”

~Eric Singer, one of the managers of the Congressional Effect Fund, the first mutual fund to explicitly seek to minimize investor exposure to potentially negative impact of new and proposed Congressional legislation on the broad stock market.

HT: Morganovich

29 Comments:

At 8/22/2010 1:23 PM, Blogger PeakTrader said...

Make Money When U.S. Congress Is Out of Session: Amity Shlaes
August 2, 2006

Economists Michael Ferguson of the University of Cincinnati and Hugh Douglas Witte of the University of Missouri at Columbia:

For the Dow, the results were dramatic. Since 1897, the year after the Dow was created, an impressive 90 percent of the gains came on days when Congress was out.

Their charts show that a dollar invested in 1897 with the strategy of going back to cash every time Congress met was worth $216 by 2000.

But an 1897 dollar invested on the reverse strategy was worth only $2 after a century.

The big gap between performances began to show up after World War I, when it became clear that Washington would play a bigger role in the country.

 
At 8/22/2010 1:52 PM, Blogger Buddy R Pacifico said...

Gridlock probably forces compromise on programs and laws which is good. The fund created to take advantage of the congressional effect will have a tax like effect on the investor.

The Congressional Effects Fd fund has the ability to charge its investors 4.97% after May 31, 2011. That means that $10,000 invested could have about $5,000 in fees taken out over ten years and the fund currently has a0% yield!

The congressional effects strategy looks whorthwhile to pursue but I'm not sure about the fund that takes its name.

 
At 8/22/2010 2:08 PM, Blogger morganovich said...

eric is a good friend and i have seen a great deal more of this data. it's very interesting stuff.

peak- that "invest during recess" is the core of the congressional effects fund strategy. eric and amity are friends (i actually met her through him). her book on the depression "the forgotten man" is excellent and really lays out how a regulatory environment in flux can paralyze the economy.

 
At 8/22/2010 4:30 PM, Blogger Stephen said...

Using gold as a deflator? Of what relevance is that?

Might as well use corn spot price as the deflator.

 
At 8/22/2010 6:40 PM, Blogger morganovich said...

stephen-

the methodology by which CPI is calculated was changed very significantly in 1992. regardless of which methodology one prefers (which has been a recurrent argument on this site) it makes using CPI as a deflator problematic as readings from before and after the change are not comparable.

 
At 8/22/2010 7:37 PM, Blogger Stephen said...

morganovich, if that's the case, then it sounds like the data aren't comparable at all. There is no basis to use gold as the deflator.

Isn't there anyone that has revised the old CPI using the new methodology?

 
At 8/22/2010 7:40 PM, Blogger Gregory (Greg) P Turco said...

Morganovich,

Regardless of the issues with the CPI, using gold is a distortion. Gold is high now, but the prices of many other assets are not high.

Using a non-standard price deflator like gold to support a political conclusion like this is dubious. A conclusion about public policy should be valid with a number of price deflators.

 
At 8/22/2010 8:03 PM, Blogger morganovich said...

stephen-

i know of people who have continued to calculate CPI the old way and therefore have a complete series (like john williams) but have not seen a series by which the old data has been recalculated using the new methods, which may well not be possible. you could maybe get the geometric weighting applied, but trying to do all the hedonic adjustments on past baskets is likely impossible, which is why not even the BLS has done it.

using the old CPI calc as a deflator would heavily favor the reagan period and significantly penalize clinton onwards in comparison to the results reported above.

greg-

i'm not arguing that gold is a perfect deflator or even that it's the one i'd choose as i am not much of a goldbug. i'm just telling you why eric used it (and i know this first hand because he told me.)

i've also seen this data run with CPI as a delfator as well as nominally and using a commodities basket (CI). you get different %'s, but the relationship of split government massively outperforming a unified one holds whatever the deflator. i wouldn't get too hung up on the choice of inflation metric. it does not affect the conclusions.

 
At 8/22/2010 9:14 PM, Blogger Junkyard_hawg1985 said...

I have two MAJOR issues:

First, using gold as a deflator is not very good. On a gold basis, the American economy in 1973 was significantly larger than it is today (oz gold GDP). Also on this basis, the economy has contracted far more since 2000 than it did in the Great Depression.

The second issue is that the time period is short. The Republican data is a single stretch for all of 6 years. I had taken the real stock market cumulative average annual returns since 1900 and compared it to party in power (R,D, or split). The data is from Crestmont Research here:

http://crestmontresearch.com/pdfs/Stock%20Matrix%20Tax%20Exempt%20Real3%2011x17.pdf

Note: this is one of the best graphical stock return charts I have ever seen.

Based on this data, the best time to be invested is when Republicans have full control. The second best (way back) is when power is split. The worst is when democrats have full control. I'll provide the CAAR for each case tomorrow.

The data uses the average stock market index for the year rather than year end result. For this type of analysis, I think this is better because it overcomes a flaw in the comparison. The flaw in using year end results is that the stock market responds to election results. If Republicans win the November election in a huge sweep, the stock market will respond favorably. Should Democrats get credit for this stock market response? The impact of late year results is muted.

 
At 8/23/2010 6:31 AM, Blogger marmico said...

Praetell. A Carpe Diem post without a line chart.

It's here. It is demonstrative of the spurious correlation of the congressional gold/stock gridlock anomaly.

There have been 3 distinct periods in the S&P500/gold relationship over the last 30 years.

1. The gold bull/stock bear market in the decade following Nixon closing the gold window in 1971.

2. The gold bear/stock bull market in the next 2 decades.

3. The gold bull/stock bear market in the last decade.

Now if Singer overlaid the unified and gridlock congressional periods on the S&P500/gold chart (and the data is available back to the creation of the S&P indicies in 1957), I would guess that no statistical significance exists.

 
At 8/23/2010 7:44 AM, Blogger Junkyard_hawg1985 said...

Here are the inflation adjusted cumulative average annual returns by party in power since 1900:

Full Republican Control: 8.0%/yr
Full Democratic Control: 3.2%/yr
Split Control: 1.8%/yr

Gridlock is NOT great for real stock returns.

As mentioned earlier, the raw data is from Crestmont research:

http://crestmontresearch.com/pdfs/Stock%20Matrix%20Tax%20Exempt%20Real3%2011x17.pdf

 
At 8/23/2010 9:07 AM, Blogger marmico said...

Dawg, your chart says nothing of the sort. What's the source of your data.

Everyone knows that real equity returns are higher in democratic presidential regimes.

The issue is whether gridlock increases returns.

As an equity investor, I'll take the presidential donkeys, with or without gridlock, and you can have the elephants, period.

For instance, in the prior 2 decades, Bush43 presided over a sad state of affairs in the equity markets compared to Clinton. Even Obama is outperforming Bush43 thus far.

 
At 8/23/2010 9:30 AM, Blogger juandos said...

"For instance, in the prior 2 decades(?!?!), Bush43 presided over a sad state of affairs in the equity markets compared to Clinton. Even Obama is outperforming Bush43 thus far"...

You failed to mention what planet this was supposedly happening on marmico, you want to let us know that salient fact?

 
At 8/23/2010 10:00 AM, Blogger marmico said...

juandos, are you the president of the planet of dummies?

January 20, 1993===>S&P500....450

January 18, 2001===>S&P500...1160

January 20, 2009===>S&P500....770

August 20, 2010====>S&P500...1072

No doubt a fifth grader will know the dates and you won't. Just stick with your ideologically driven drivel from your CATO, Heritage, AEI links and refrain from ad hominems on threads where your intellectual deficiencies are patently obvious.

 
At 8/23/2010 10:16 AM, Blogger juandos said...

"juandos, are you the president of the planet of dummies?"...

Speaking of dummies, you need to do more homework...

Big numbers don't necessarily translate to big earnings...

 
At 8/23/2010 11:18 AM, Blogger Benjamin said...

I agree with Stephen--the CPI is not perfect, but it is the best tool we have for measuring inflation.

Gold is driven by gold nuts, investment fevers, and lately rapidly growing disposable income in India and China, where there has been a historic affintity for gold. Indeed, inflation has been low to zero in the USA during one of the great gold bubbles of all time.

Or wouldn't using the CPI give the result wanted?

Woudl like to see this chart

 
At 8/23/2010 12:32 PM, Blogger Junkyard_hawg1985 said...

marmico,

In your response to Juandos, you

a) provide index numbers that do not include the effect of dividends which historically have been the major parameter of real return.
b) do not include inflation which is the second largest long term parameter.
c) do not include the effect of the election on the stock market (i.e. on Election day 2008 the S&P500 closed at 1005. On inaguration day, it closed at 805.) The stock market is forward looking and the 20% drop does not sound like they were looking forward to Obama.
d) Ignores the effect of Congress.
e) Provide S&P 500 data that does not reflect the actual value of the S&P 500.

After this, you call Juandos a dummy.

 
At 8/23/2010 12:35 PM, Blogger morganovich said...

marmico-

those are presidential dates. try break it up by control of congress.

clinton 93-94 - dem congress

spx - 435-459 (+2.7% yr)

95-2000 republican congress-

spx 459-1320 (+19%/yr)

you certainly level a lot of insults for someone unable to follow the basic thrust of the conversation.

 
At 8/23/2010 12:51 PM, Blogger morganovich said...

hawg-

you can't really use CPI as a deflator across the 1992 splice when methodology changed. the difference in reported CPI between the new and old system is huge. even the direction of the trend varied from 92-2002. using the CPI methodology used prior to clinton, inflation was rising that whole time and was around 10% in 2000 vs the 3% reported.

regardless of which measure you thing more accurately reflects price levels, there is not question that comparing data pre and post 1992 is apples and oranges. either all past inflation is significantly overstated, or all modern inflation is understated.

absent a consistent price series, you cannot make accurate comparisons of real return across 1992.

 
At 8/23/2010 1:48 PM, Blogger Benjamin said...

Morganivich-

Many times you have cited that the new CPI measures a much lower rate of inflation than the older CPI.

Fine.

Have you ever added up what you think the total under-reporting of inflation is, since 1992?

It looks to me like you are suggesting 1-2 percent a year undercounting of inflation, minimum.

This would suggest that American living standards and wages are actually 20-30 percent or so lower than reported.

Does this make any sense to you?

 
At 8/23/2010 3:21 PM, Blogger marmico said...

Bush43 got absolutely creamed in the gridlocked 107th and 110th Congress but did well above average in the unified 108th and about average in the unified 109th Congress.

Clinton did well above average in the gridlocked 104th and 105th Congress, slightly below average in the unified 103rd Congress and below average in the gridlocked 106th Congress.

An investor made money in the stock market in the Clinton era, gridlocked or unified. Not so with Bush43.

Sources: The Balance Of Power Between Congress and The Presidency

CAGR of the Stock Market (total, real for the hawg)

 
At 8/23/2010 4:00 PM, Blogger Junkyard_hawg1985 said...

marmico,

Thanks for the link on CAGR. I added it to my favorites.

Using the data from the link you provided (year end instead of annual average), the CAAR based on party in power since 1901 is:

Republicans: 10.87%/yr
Democrats: 6.75%/yr
Split Control: 3.15%/yr

Over a 30 year investment lifetime, you end up 3X richer with Republicans in power than Democrats and 8X richer than with power split.

 
At 8/23/2010 4:16 PM, Blogger Junkyard_hawg1985 said...

Marmico,

I have one adjustment to the data. Since we are not using annual averages, I moved 2001 from a Republican controlled year to a split power year. Jim Jeffords switched parties on May 24, 2001 and the government was no longer unified. The year started with the S&P500 at 1283 and closed at 1293 on May 24. It then fell to 1122 by the end of the year so the entire drop occurred during split power. Here are the updated numbers:

Republicans: 11.44%/yr
Democrats: 6.75%/yr
Split Control: 2.82%/yr

In either case, contrary to the headline of this article, gridlock is NOT great for stock market returns.

Morganovich,

Since most of the post 1992 data is with split power, the difference between split power and shared power would be larger, not smaller.

 
At 8/23/2010 5:01 PM, Blogger marmico said...

hawg, more data points. What do you mean by split control? Is that a split congress or a split president/congress, and if a split president/congress is that a split president/senate or president/house?

Morganovich. Read this. Then compare the CPI-U-RS to the CPI-U.

 
At 8/23/2010 9:58 PM, Blogger OBloodyHell said...

> An investor made money in the stock market in the Clinton era, gridlocked or unified. Not so with Bush43.

Yeah, because the tech market bubble of the 90s, which bush got the downswing of -- that's not even vaguely relevant.

No, not in the least.

Here's a little secret: Around here, people CAN recall the external effects which might be applicable, genius.

Go back to making your claims on the DK and the DU and the HuffPo where those around you are too economically batsh** stupid to see the glaring flaws in your arguments.

 
At 8/23/2010 10:09 PM, Blogger Junkyard_hawg1985 said...

marmico,

For a bill or budget to be passed into law, it must pass the House, the Senate and be signed by the president (or veto override). Full control means a single party controls all three (like the democrats do today).

 
At 8/24/2010 9:25 AM, Blogger Hydra said...

"Yeah, because the tech market bubble of the 90s, which bush got the downswing of ..."

=============================

Wait a minute. Didn't you just say the market is forward looking? Or is it only forard looking when the historical data suits your message?

 
At 8/24/2010 10:10 AM, Blogger Paul said...

"Wait a minute. Didn't you just say the market is forward looking? Or is it only forard looking when the historical data suits your message?"

I don't see a contradiction. There was a tech bubble, and a Y2K bubble that people seem to forget. In the late 90's, every large corporation in the country was suddenly in synch upgrading equipment and hiring tech workers at a furious pace in order to survive the potential debacle of Jan 1, 2000. Turned out to be a dud. But scores of unneeded workers were let go shortly after, and there was no need to make any more mass purchases of hardware from Dell, Cisco, Microsoft, etc. for at least a few more years.

Out goes Clinton as the roof starts caving in, and in walks Bush. Forward looking or no, the market was going to tank.

 
At 8/26/2010 9:29 AM, Blogger SweetLiberty said...

An important distinction to consider: the Clinton/Republican split created an unsustainable bubble which resulted in the first economic decline of the new century, whereas the Reagan/Democrat policies brought extended prosperity for quite some time.

 

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