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Political Indicators

It is plausible that political winds might sway the economy and therefore financial markets. To what degree do politics matter for equity investors? Should they worry about the philosophy of the party in power or unusual market behavior relative to elections? Should they act on the prognostications of political experts? These blog entries address relationships between politics and the stock market.

Should Investors Care About “the Way Things Are Going”?

Are broad measures of public sociopolitical sentiment relevant to investors? Do they predict stock returns as indicators of exuberance and fear? To investigate, we relate S&P 500 Index return and 12-month trailing S&P 500 price-operating earnings ratio (P/E) to the percentage of respondents saying “yes” to the recurring Gallup polling question: “In general, are you satisfied or dissatisfied with the way things are going in the United States at this time?” Since individual polls span several days, we use S&P 500 Index levels for about the middle of the polling interval. To calculate market P/E, we use current S&P 500 Index level and most recent quarterly aggregate operating earnings. Using Gallup polling resultsS&P 500 Index levels and 12-month trailing S&P 500 operating earnings as available during July 1990 (when polling frequency becomes about monthly) through June 2019, we find that: Keep Reading

Monthly Returns During Presidential and Congressional Election Years

Do hopes and fears of election outcomes in the U.S. affect the “normal” seasonal variation in monthly stock market returns? To check, we compare average returns and variabilities (standard deviations of returns) by calendar month for the Dow Jones Industrial Average (DJIA) during years with and without quadrennial U.S. presidential elections and biennial congressional elections. Using monthly closes for the DJIA over the period October 1928 through May 2019 (nearly 91 years), we find that: Keep Reading

Short-term Equity Risk More Political Than Economic?

How does news flow interact with short-term stock market return? In their April 2019 paper entitled “Forecasting the Equity Premium: Mind the News!”, Philipp Adämmer and Rainer Schüssler test the ability of a machine learning algorithm, the correlated topic model (CTM), to predict the monthly U.S. equity premium based on information in news articles. Their news inputs consist of about 700,000 articles from the New York Times and the Washington Post during June 1980 through December 2018, with early data used for learning and model calibration and data since January 1999 used for out-of-sample testing. They measure the U.S. stock market equity premium as S&P 500 Index return minus the risk-free rate. Specifically, they each month:

  1. Update news time series arbitrarily segmented into 100 topics (with robustness checks for 75, 125 and 150 topics).
  2. Execute a linear regression to predict the equity premium for each of the 100 topical news flows.
  3. Calculate an average prediction across the 100 regressions.
  4. Update a model (CTMSw) that switches between the best individual topic prediction and the average of 100 predictions, combining the flexibility of model selection with the robustness of model averaging.

They use the inception-to-date (expanding window) average historical equity premium as a benchmark. They include mean-variance optimal portfolio tests that each month allocate to the stock market and the risk-free rate based on either the news model or the historical average equity premium prediction, with the equity return variance computed from either 21-day rolling windows of daily returns or an expanding window of monthly returns. They constrain the equity allocation for this portfolio between 50% short and 150% long, with 0.5% trading frictions. Using the specified news inputs and monthly excess return for the S&P 500 Index during June 1980 through December 2018, they find that:

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Stock Market and the National Election Cycle

Some stock market experts cite the year (1, 2, 3 or 4) of the U.S. presidential term cycle as a useful indicator of U.S. stock market returns. Game theory suggests that presidents deliver bad news immediately after being elected and do everything in their power to create good news just before ensuing biennial elections. Are some presidential term cycle years reliably good or bad? If so, are these abnormal returns concentrated in certain quarters? Finally, what does the stock market do in the period immediately before and after a national election? Using daily and monthly S&P 500 Index levels from January 1950 through August 2018 (nearly 69 years and about 17 presidential terms) and focusing on “political quarters” (Feb-Apr, May-Jul, Aug-Oct and Nov-Jan), we find that: Keep Reading

Economic Policy Uncertainty and the Stock Market

Does quantified uncertainty in government economic policy reliably predict stock market returns? To investigate, we consider the U.S. Economic Policy Uncertainty (EPU) Index, created by Scott Baker, Nicholas Bloom and Steven Davis and constructed from three components: (1) coverage of policy-related economic uncertainty by prominent newspapers: (2) the number of temporary federal tax code provisions set to expire in future years; and, (3) the level of disagreement in one-year forecasts among participants in the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters for both (a) the consumer price index (CPI) and (b) purchasing of goods and services by federal, state and local governments. They first normalize each component by its own standard deviation prior to January 2012. They then compute a weighted average of components, assigning a weight of one half to news coverage and one sixth each to tax code uncertainty, CPI forecast disagreement and government purchasing forecast disagreement. They update the EPU index monthly with a delay of about one month, including revisions to recent months. Using monthly levels of the EPU Index and the S&P 500 Index during January 1985 through June 2018, we find that: Keep Reading

Ziemba Party Holding Presidency Strategy Update

“Exploiting the Presidential Cycle and Party in Power” summarizes strategies that hold small stocks (large stock or bonds) when Democrats (Republicans) hold the U.S. presidency. How has this strategy performed in recent years? To investigate, we consider three strategy alternatives using exchange-traded funds (ETF):

  1. D-IWM:R-SPY: hold iShares Russell 2000 (IWM) when Democrats hold the presidency and SPDR S&P 500 (SPY) when Republicans hold it.
  2. D-IWM:R-LQD: hold IWM when Democrats hold the presidency and iShares iBoxx Investment Grade Corporate Bond (LQD) when Republicans hold it.
  3. D-IWM:R-IEF: hold IWM when Democrats hold the presidency and iShares 7-10 Year Treasury Bond (IEF) when Republicans hold it.

We use calendar years to determine party holding the presidency. As benchmarks, we consider buying and holding each of SPY, IWM, LQD or IEF and annually rebalanced portfolios of 60% SPY and 40% LQD (60 SPY-40 LQD) or 60% SPY and 40% IEF (60 SPY-40 IEF). We consider as performance metrics: average annual excess return (relative to the yield on 1-year U.S. Treasury notes at the beginning of each year); standard deviation of annual excess returns; annual Sharpe ratio; compound annual growth rate (CAGR); and, maximum annual drawdown (annual MaxDD). We assume portfolio switching/rebalancing frictions are negligible. Except for CAGR, computations are for full calendar years only. Using monthly dividend-adjusted closing prices for the specified ETFs during July 2002 (limited by LQD and IEF) through April 2018, we find that:

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Party in Power and Stock Returns

Past research relating U.S. stock market returns to the party holding the Presidency mostly concludes that Democratic presidents are better for the stock market than Republican presidents. However, the President shares power conferred by the electorate with Congress. Does historical data confirm that Democratic control of Congress is also better for stock market returns than Republican control of Congress? Is control of the smaller Senate more decisive than control of the House of Representatives? To check, we relate annual U.S. stock market (S&P 500 Index) returns to various combinations of party control of the Presidency, the Senate and the House of Representatives. Using party in power data and annual levels of the S&P 500 Index for 1950 through 2017 (68 years), we find that: Keep Reading

Hope for Stocks Around Inauguration Days?

Do investors swing toward optimism around U.S. presidential inauguration days, focusing on future opportunities? Or, does the day remind investors of political uncertainty and conflict? To investigate, we analyze the historical returns of the Dow Jones Industrial Average (DJIA) around inauguration day. Using historical inauguration dates since 1929 (22 inaugurations) and contemporaneous daily closing levels of DJIA through January 2013, we find that: Keep Reading

Divided Government Risk Premium?

Do investors demand a risk premium for divided government because of the policy uncertainty of gridlock? In the April 2013 preliminary draft of their paper entitled “Divided Governments and Asset Prices”, Elvira Sojli and Wing Wah Tham„ investigate the effect of divided government on asset prices by comparing U.S. stock market performance in years of divided and undivided government. They define divided government (in the U.S.) as one party holding the Presidency while the other controls one or both houses of Congress. To isolate the effects of divided government, they account for the states of four variables widely used to predict stock market returns: dividend-price ratio; credit default spread, the difference between BAA and AAA corporate bond yields; term spread, the difference between 10-year U.S. Treasury note and 3-month U.S. Treasury bill (T-bill) yields; and, deviation of the 3-month T-bill yield from its one-year moving average. To determine causality, they investigate stock market futures reactions to betting market predictions of divided versus undivided government during four election nights. Using monthly U.S. stock market returns, data for the four stock return predictors and U.S. Treasury bill yields during 1926 through 2011 (encompassing 43 elections resulting in 23 undivided and 20 divided governments), and high-frequency election outcome betting data (from Intrade) and U.S. stock market futures on biennial election nights during 2004 through 2010, they find that: Keep Reading

A Few Notes on Trade the Congressional Effect

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: Keep Reading

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