Oct. 23 (Bloomberg) — Obama, OK. Obama-Pelosi-Reid? A nightmare for markets. McCain-Pelosi-Reid? OK. McCain and Republican majorities in both House and Senate? Another nightmare.
That at least is the analysis of Eric Singer of Congressional Effect Fund, a new mutual fund. As noted in an earlier column, Singer got into the index business after he found that the Standard & Poor's 500 Index performs two or three times better when Congress is out of session than when at least one of the two chambers is at work.
That difference, Singer discovered, wasn't because of political party — a laboring Republican Congress was also problematic. The poor performance, rather, reflects market anxiety that the House and Senate generate when they pass a new regulation or revise laws already on the books. Simple congressional workday chatter about possible changes is also negative, according to the Singer data.
"Even talk is not cheap," he says.
This past August, with Congress safely on holiday, markets were still weird. That set Singer to wondering anew.
He noted that there were years, such as 1998, in the middle of Congress's Republican reassertion, when markets did great even when lawmakers were at their posts.
Combing his data back to 1965, Singer found a second trend. A split Washington, in which at least one of the two chambers is led by a party other than the president's, points to a better total return for the S&P 500 than a unified Washington in which the presidency, House and Senate are controlled by one party.
Clinton Constrained
Having Democrat Bill Clinton in the White House in 1998 constrained congressional Republicans, or the other way around.
Singer found that the average annual total return for the S&P 500 when Washington is a one-party town is 9.4 percent. The average performance for the index when Washington is split is 10.6 percent.
The distinction becomes clearer when you adjust for inflation. Singer used the annual average of the daily gold price as a deflator rather than a year-over-year number because he wanted to screen for the volatility of commodities. Singer found that in periods of a unified Washington, the S&P 500 averages real losses of 7.8 percent. A split Washington, by contrast, racks up a real gain averaging 8.7 percent. That 16-plus point spread is the quantification of the peril of a powerful Washington.
These numbers also suggest that inflation tends to be worse in unified years. This makes sense — when Washington is mightier, one fashion in which it uses its power is minting money, consequences be damned. A Federal Reserve chairman who must report to only one party, instead of two, has fewer rounds to make when he seeks support for the Fed's actions.
Drama Days
The Singer method also captures the drama of 1980. Washington was all Democratic, though it was clear even in the spring that Ronald Reagan might win the presidency.
The market reacted by rising in anticipation of a change. The price of gold reacted by falling late in the year. One might argue that this reflected the market's faith that Reagan would spend less than President Jimmy Carter. But the change in gold prices may also have been the result of political division within the Democratic Party.
The new Fed chairman, Paul Volcker — a Democrat who today is advising Senator Barack Obama in the race for president against John McCain — started applying the brakes at the Fed. By exercising monetary restraint, a trait identified at the time with the Republican Party, Volcker — with backing from Carter — provided a counterweight to free spenders of either party.
Hurting Returns
An all-Republican Washington can hurt real total returns, too. In 2005, the S&P gain of 4.9 percent was more than erased by the 8.5 percent increase in the price of gold. In 2006, gold was up about 36 percent but the S&P climbed only 16 percent, a net 20 percent loss.
The scholars who look at this sort of thing all have slightly different takes on it. Some quibble, for example, with Singer's choice of gold as a measure of inflation. But recent events confirm the validity of the gold meter. The consumer price index shows an increase of only 2.5 percent between December 2005 and December 2006 — quite a contrast with that 36 percent increase in gold for the year. Today's markets suggest that gold did a better job than the CPI of predicting bubbles.
In Singer's data we see early discounting for this year's stock price collapse.
It's been said of numbers that if you torture them enough they will admit to anything. This year Congress and the White House were held by different parties, and we still managed to have our historic crash.
Getting Ready
Markets, which don't care whose campaign they ruin, may also be bracing for an all-Democratic Washington. Consumers may also be spending less not only because of the market turmoil but also because they believe a government dominated by Democrats may, in the future, allow them to keep less of their earnings.
This would fit in with the late Milton Friedman's permanent-income hypothesis. Singer is now studying market performance when a single party holds not only the White House and Congress, but also a filibuster-proof majority in the Senate. With each passing day that, too, looks like a number worth crunching.
(Amity Shlaes, a senior fellow in economic history at the Council on Foreign Relations and author of "The Forgotten Man: A New History of the Great Depression," is a Bloomberg News columnist. The opinions expressed are her own.)
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