Spokane Journal of Business

Investment returns linked more to policy than party

Some conventional thought on election results' effects on securities said 'spurious'

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In a recently completed study, the authors of several widely-recognized articles on politics and investment returns challenge conventional wisdom regarding the association between such returns and political election results.

Robert R. Johnson, professor of finance at Creighton University College of Business, and three co-authors say they have conducted a comprehensive examination by analyzing several political- and monetary-policy variables and conclude that some previous findings regarding political associations and asset returns are likely "spurious."

In their study, "What to Expect When You're Electing, "authors contend that investors should focus less attention on the party of the president and instead more closely monitor Federal Reserve actions. Furthermore, they say their findings suggest that political harmony should be welcomed by equity investors, but not debt investors. Finally, they say that regardless of the political outcome, if the past serves as a guide, investors might have to wait until year three of the next presidential term to enjoy the fruits of the current political season.

The study considers investment returns from 1965 through 2008. The authors examine several dimensions of the political landscape—the party of the president, the presence or absence of political gridlock (when the Senate, Congress, and Oval Office are not all controlled by the same political party), and the presidential term effect (the phenomenon that returns are highest in the third year of a presidential term)—in conjunction with Fed monetary policy in examining long-term returns.

The authors say the joint analysis allows them to isolate the relationship that a particular political factor has with investment returns by controlling for other relevant factors. Since returns likely are influenced by both fiscal and monetary policy, they assert, failure to consider the variables within a joint analysis increases the likelihood of producing misleading and biased findings.

They say the key empirical findings reported in the study are consistent with the following:

•Equity investors, especially those that target small-cap stocks, would be wise to monitor Fed policy actions, while paying limited attention to the party of the president. Investors should be particularly wary of a shift to a restrictive Fed monetary policy.

•Contrary to the conventional view, equity investors should welcome political harmony; however, debt investors should prefer continued political gridlock.

•Fed policy shifts warrant consideration as potential signals of coming inflationary pressures. A shift to a restrictive policy stance should alert investors to higher future inflation and support a re-allocation to securities, such as commodities, that offer more inflation protection.

"The return relationships that many financial commentators attribute to the party of the President and political gridlock appear to be spurious," Johnson says. "While the evidence is consistent with the view that effective portfolio strategies require investors to carefully monitor both monetary and fiscal policy developments, there is no support for the widely held view that gridlock is beneficial for equity markets or for the claim that party of the President systematically influences security returns."

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