Tuesday, November 2, 2010

What Should Investors Expect Post-Election?

Regardless of the election results, investors will wake up tomorrow still faced with the task of finding investment value in a low growth, low interest rate world.

Conventional wisdom is that a gridlocked government - which this morning seems likely, with Republicans poised for some big wins in Congress - is good for the stock market. However, based on past history, this might not be the case.

Slate magazine carried an interesting article on what historic returns have been for stocks in different political environments (tip of the hat to Ezra Klein of the Washington Post for bringing the article to my attention). Here's a couple of excerpts from the piece, with the full link below.

First, the near term outlook:

One thing is certain: Markets love midterm elections. Brian Gendreau, a market strategist for Financial Network, found that the Dow has risen after 19 of the 22 most recent midterms. From 1922 to 2006, the Dow jumped 8.5 percent in the 90 trading days following the midterms, versus just 3.6 percent in non-midterm-election years.

But longer term, according to Sam Stovall of Standard & Poor's:

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.
And in terms of sectors:

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 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.

To me, the best conclusion to draw from all of this is that you have several reasons to be bullish on the near term outlook for stocks, at least based on historic cycles.

First, as noted above, midterm elections tend to be good for stocks. In addition, the third year of any presidential cycle tends to have strong investment results. Politically, then, you have some tailwinds.

Next, the Fed will almost certainly begin the next round of quantitative easing either later this week or next. No one knows how large the program will be, but this too should provide some stock market boost.

Finally, the period from November to January has historically provided the best stock market returns.

Should be an interesting period ahead.

Why is the stock market looking forward to political gridlock? - By Annie Lowrey - Slate Magazine