Insight Line—March 3, 2008

In every presidential election year, voters and investors alike focus on the race for the White House, and rightfully so. You see, the historical data depicts market returns that vary greatly under Republican or Democratic leadership in the White House and in Congress (see chart below).

Source Ned Davis Research, Inc.

The same data also suggests that while presidential races may dominate the statistical landscape, a more interesting interaction between politics, the public and stock prices is likely to take shape. And, it has very little to do with who wins or who loses. Allow me to explain.

As Election Day approaches, strategists and pundits willingly offer prognostications on how the perceived election outcome might bias future market price action. Though the supporting documentation lending credence to their logic is, to be sure, impressive, I just cannot get past that old statistical saw, “torture the data enough and you can get it to confess anything.”

Early in 2006 Professors Michael Ferguson and H. Douglas Witte from the University of Cincinnati and the University of Missouri, respectively, offered up an enlightening—and subtlety humorous—investing theory. Calling it the Congressional Effect, Ferguson and Witte demonstrate that equity returns seemingly respond less to which party holds the Congressional majority and more toward whether Congress was actually in session.³

Using historical pricing on the Dow Jones Industrial Average (DJIA), the Standard and Poor’s 500 Stock Index (S&P 500), the Center for Research in Security Prices (CRSP) Equal-Weighted Returns Index and the CRSP Value-Weighted Returns Index,⁴ Ferguson and Witte find that, “Returns are significantly higher and volatility is significantly lower when Congress is out of session.”⁵ In fact, they note, “Fully 90 percent of the historical capital gains on the DJIA occurred on days when Congress was out of session.”⁶

Perhaps even more striking was their finding that—all other external influences being equal—the historical variations in daily returns appear to be influenced by public opinion of the sitting Congress and its actions. You see, according to Ferguson and Witte, the more the public disapproves of Congressional actions the higher the likelihood stock returns may suffer while Congress is in session—irrespective of party dominance. The researchers surmise that such public negativity could correspond with rising uncertainty amongst investors over potential changes to the tax and regulatory environment. Interestingly enough, the converse—that is, a favorable public opinion of the sitting Congress leading to reduced market volatility—is less discernable in the data. The researchers could not offer a strong opinion as to the cause of this weaker statistical relationship, other than perhaps Congressional actions being more in line with majority public opinion. Nonetheless, they conclude, “The most compelling evidence that the Congressional Effect is a real economic phenomenon is the finding that the Effect for mean returns and volatility varies systematically with the public’s attitude toward Congress.”⁷

Given this framework, I believe Wall Street pundits’ forecasts on the interaction between perceived election outcomes and stock returns should carry little weight for a long-term investor. Considering recent opinion polls of Congress (in effect, near historical lows),⁸ I am skeptical that unless any change in majority leadership in either or both houses of Congress results in a meaningful variance in national approval polls, all of the pre-election rhetoric is just that. In which case, once the dust settles on election night, investors will likely turn back to the business at hand: investing for the long term and not the next political cycle.

¹ Source: Ned Davis Research, Report T_50, for the period 03/04/1901–02/21/2008, © 2008 Ned Davis, Inc.

² The Dow Jones Industrial Average (DJIA) measures the performance of 30 blue chip stocks and is a commonly cited gauge of the U.S. stock market. The indexes shown throughout this commentary do not include any expenses, fees or sales charges, which would lower performance. The indexes are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

³ Ferguson, Michael and H. Douglas Witte, “Congress and the Stock Market,” March 13, 2006. Available at SSRN: http://ssrn.com/abstract=687211

⁴ The Standard and Poor’s 500® Index (S&P 500) is a broad-based index, the performance of which is based on the performance of 500 widely-held common stocks chosen for market size, liquidity and industry group representation. The Center for Research in Security Prices (CRSP) Equal-Weighted Returns Index is an average of the returns of all traded stocks and the CRSP Value-Weighted Returns Index is a weighted average of all stock returns, with weightings determined by market capitalization value. Ferguson and Witte note that the index data used in their study have various starting points: 1897 for the DJIA, 1957 for the S&P 500 and 1962 for the CRSP indexes, and the ending period for the study is December 2004.

⁵ Ferguson and Witte, page 2

⁶ Ferguson and Witte, page 7

⁷ Ferguson and Witte, page 23

⁸ Source: www.pollingreport.com/CongJob.htm
 

This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy. The forecasts and opinions in this piece are not necessarily those of Van Kampen, and may not actually come to pass. Information in this report does not pertain to any Van Kampen product and is not a solicitation for any product.