“Is gridlock good—that is, should investors root against having the same political party control both Congress and the White House? Who is better for stock and bond returns: Republicans or Democrats? Most of the answers you are likely to find are propaganda or wishful thinking: many are flat-out wrong. What matters are changes in interest rates, not which party passes through the White House gates.”
Um…yes and no. Research does find a strong relationship between interest rates and security prices. But there is an alternative view that investors would benefit from a more nuanced consideration of the impact of politics and government on businesses, and on the securities that those businesses issue.
· There’s more to the impact of government policy changes. Monetary policy (that sets interest rates) has a big impact on the stock and bond markets; but so do many other policy levers that elected officials can manipulate, such as fiscal policy (how much the government spends), tax policy (who pays taxes, and how), trade policy (how much the government protects domestic industry), and a legion of regulations (such as labor, environment, banking, and consumer safety) that affect the ability of businesses to adapt to ongoing processes of creative destruction in market economies. The unwillingness of the Obama Administration to license new coal-burning power plants in the U.S. has had enormous impact on the coal mining industry and related industries such as rail transportation. The Smoot-Hawley Act of 1930 that erected a strong protectionist tariff was a major determinant of the depth of the Great Depression. The Sherman Anti-Trust Act of 1890 and the Federal Trade Commission Act of 1914 gave government the power to forestall anticompetitive policies, break up monopolies, and perhaps dictate industrial policy. Research has established the consequence of these policy levers to economic growth and ultimately, returns to investors. The lesson is that while monetary policy may have the most immediate impact on security prices, these other policy levers can be potent and long-lasting influences on returns to investors.
· One size does not fit all. Though we like to think of the economy and the stock market rising and falling in a visible cycle, the aggregate cycle masks enormous variations across industries and firms. Though the economy contracted sharply in the Global Financial Crisis and Great Recession, three sectors actually grew: energy, health care, and the Federal Government. The lesson is that it can pay investors to consider the impact of macro events such as changes in government policy on specific industries and firms, rather than just the aggregate stock market.
· Will history repeat itself? The research that Jason Zweig cites draws its conclusions from stock market returns between 1965 and 2008–this may yield a healthy slice of data. And as readers of this blog will note, I have been consistent in quoting Sir John Templeton, who said, “The four most dangerous words in investing are, ‘This time it’s different.’” We must pay attention to history’s lessons for today and the future. But in many respects, the present seems quite unlike anything we’ve seen before. Obamacare and Dodd-Frank promise to dramatically alter major sectors of the economy. The rise of the Tea Party on the right and Occupy Wall Street on the left suggest rising polarization among the American electorate. Massive government debts in the U.S. and abroad will linger for a decade or more and fit a tourniquet of austerity on households, businesses and governments. And the rise of China as a global competitor to the U.S. and of Islamic radicalism challenge a great deal of conventional wisdom about the geopolitical future and the global economy. In short, this moment in American political history seems like those blank areas on Renaissance maps that said, “here be dragons.” The lesson is that old rules of thumb about investing may be less relevant today.
To be clear, I don’t question the suggestion of Zweig or the researchers that political parties in power tend not to explain much about returns to investors. But I think it would be a vast mistake to infer that politics doesn’t matter.
The premise that politics may very well matter to investors is the focus of our forthcoming conference:
In my just-previous post, I described the impressive line-up of speakers and topics; more details are available at the conference web site. The main purpose of this conference is to jump-start investors’ reassessment of the post-election outlook.
Whatever the outcome of the U.S. elections on November 6th, interpreting their implications for investors will be an urgent task for months to come. To do so effectively, my counsel is that investors should:
· Remember the variety of policy levers in the hands of government.
· Remember that policy changes will have differential impacts on different industries, and even on different firms within those industries.
· Remember that the old rules may change in light of the remarkable new conditions in which the economy finds itself. Here may be dragons.