A Few Notes on Trade the Congressional Effect
November 12, 2012 • Posted in Political Indicators
Eric Singer, manager of the Congressional Effect Fund (CEFFX), introduces his 2012 book, Trade the Congressional Effect: How to Profit from Congress’s Impact on the Stock Market, by stating: “This book provides a new, empirically objective way to understand day by day what our government takes away from all of us. It shows in hard numbers what we lose out of our wallet when Congress acts. …this book suggests concrete investing strategies to make Congress’s systemic dysfunction work for you, and to hedge the risk and damage that Congress so casually and relentlessly inflicts on your life savings as represented by your portfolio and your house.” Using examples of legislative intervention and focusing on the daily level of the S&P 500 Index (capital gains only) during 1965 through 2011, he concludes that:
From Chapter 1, “What Is the Congressional Effect?” (Pages 21-22): “Ignoring dividends and transaction costs, from 1965 through 2011, measuring each of the 11,832 trading days during that period, the price of the S&P 500 Index rose at an annualized rate of 0.72 percent on days Congress was in session, but 16.60 percent on days they were out of session… A dollar invested at the beginning of 2002 through the end of 2011 just on in-session days would have turned into $0.61, while the same dollar invested just on out-of-session days would have compounded into $1.56.”
From Chapter 2, “Congressional Effect and Limits of Modern Portfolio Theory” (Page 39): “The Congressional Effect shows that MPT’s key assumption–that daily returns are randomly distributed–is wrong. The statistical data in support of this is overwhelming.”
From Chapter 3, “Congressman as Issues Entrepreneurs” (Page 58): “…with 535 issues entrepreneurs fighting for the limelight, there will be a constant eruption of news and proposals that relentlessly try to alter the existing business plans of each sector of American industry.”
From Chapter 4, “Behavioral Finance, the Stock Market, and Congressional Dysfunction” (Page 78): “The Congressional Effect exists in no small part because every day millions of market participants and thousands of their fiduciaries watch Congress with sustained dread knowing that they will spend most of their energy promoting the wrong thing to do at exactly the wrong moment.”
From Chapter 5, “If Congress is Malfunction Junction, What’s Its Function?” (Page 95): “…when a large industry is in Congress’s gun sights, it will likely underperform the market for an extended period of time before Congress starts to realize the unintended consequences of its actions.”
From Chapter 6, “Where Will Washington Strike Next?” (Page 124): “Use television, newspapers, radio, and online political resources: they will be the first to inform you when there is legislation affecting a specific sector or company. Think tanks and political blogs will also provide secondary insight…”
From Chapter 7, “Sidestepping Congress’s Wealth Destruction with a Macro Approach” (Page 136): “One way to systematically reduce legislative risk is to have little or no equity exposure just on the days Congress is in session.”
From Chapter 8, “Are Democrats or Republicans Better for Your Portfolio” (Page 149): “…there is a compelling validation of split government as being better for real wealth creation. I believe this is attributable to the fact that split government usually but not always reduces legislative risk because divided government is less likely to pass new legislation.”
From Chapter 9, “Leveraging the Election Cycle” (Pages 156-157): “There is some statistical evidence that the third year of a presidential cycle is good for investors. …if the Democrats retain control of the Senate, it would be wise to have relatively more gold in your portfolio.”
From Chapter 10, “Are Lame Ducks, Impeachments, Resignations, Vetoes, and Litigated Elections Good for the Market?” (Page 171): “…whenever the government is preoccupied with itself, it is better for the market…”
From Chapter 11, “More Ways to Dodge Congress’s Stray Bullets” (Page 182): “The key to avoiding wealth destruction by Congress is to have investing time horizons that take you past Congress’s relentless dysfunction in the moment. …You can…do it by adopting strategies such as value investing… Investors should have some portion of their assets in gold… International funds obviously are much less directly impacted by Congress’s actions…”
From Chapter 12, “That Government Is Best that Governs Least” (Page 198): “In industry after industry, there has been too much emphasis by the government on almost completely eliminating risk when in fact the biggest creator of risk is the government itself.”
In summary, investors may find arguments in Trade the Congressional Effect regarding the effects of continual and perhaps intensifying U.S. legislative disruption of business planning/performance interesting, but evidence of exploitability is not overwhelming.
Cautions regarding arguments/findings include:
- Political beliefs are often resistant to empirical tests.
- Findings about the Congressional Effect may be sensitive to precise implementation assumptions. Results in “Do Investors Prefer an Idle Congress?”, which applies a strict definition of Congress being in or out of session per the Library of Congress record, generally do not agree with those described above.
- Applying a strict definition of Congress being in or out of session implies considerable trading to avoid in-session days. For example, since the introduction of SPDR S&P 500 (SPY) at the end of January 1993, an investor would trade 988 times to be in (out of) stocks on days Congress is out of (in) session. Cumulative trading frictions would therefore be material to performance of a trading strategy avoiding in-session days.
- Applying this same strict definition, Congress is in session about 62% of the time since the introduction of SPY. Dividends accrued while in session may therefore be materially larger than those accrued while out of session.
- Comparing the performance of the Congressional Effect Investor (CEFFX) fund to that of the S&P 500 Index (as in Chapter 7) is misleading since the latter does not include dividends. From inception on May 23, 2008 through November 6, 2012, the fund has a total (dividend-adjusted) return of 3.7%, compared to 14.4% for buying and holding SPY.