Singer: Split Government Means Better Returns

Tuesday, 17 Aug 2010 04:59 PM

By Eric Singer

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As managers of the Congressional Effect Fund, we recently were asked to update our perspective on how the stock market does when government is divided. The results were intriguing.

First, a divided or gridlocked government is one in which the President and at least one chamber of Congress are from different political parties. Since we agree with Tom Paine “that government is best that governs least,” it stands to reason that the stock market should do better when government is less intrusive and the data should show that a gridlocked government would give greater returns to investors.

We went to test this idea. There has been much written about whether Democrats or Republicans are better for the stock market, and whether the Presidential political affiliation is more important than Congressional party affiliation.

We do not take a position on that issue but only ask, given an upcoming election, what does the market tell us historically about total returns of divided and unified government? We ask this question particularly in light of the recent Rasmussen poll showing that 57 percent of Americans would, if they could, get rid of every member of Congress and start fresh.

Similarly, a Gallup poll shows 75 percent of Americans disapprove of the job Congress is doing, with an additional 6 percent unsure, leaving only 19 percent of Americans approving of Congress.

What we found was astonishing.

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. That’s a 25 percent 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.

It also helps to use this technique to figure out why we don’t necessarily feel elated when the stock market goes up but gold goes up more. We know we are losing purchasing power even though the nominal economy and markets may seem good.

For example, in 2006, the S&P 500 was up 15.8 percent but gold went up even more, rising 23.22 percent. So, the nominal gains in a year of unified Republican government masked an erosion of our purchasing power.

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.

That last point is an important one. Because media attention naturally focuses on the president, it is easy to fall into the trap of believing that it is the president rather than Congress that has the most power over the economy.

Of the two, we believe it is actually Congress, although in general we think the ability of Congress to help the economy is often overstated, while its ability to harm the economy is largely ignored.

Taken as a whole, the data says what we know in our gut: When it comes to split government and real returns, the right answer is “divided we stand, united we fall.”

© 2014 Moneynews. All rights reserved.

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