Friday, January 26, 2007

Political Gains

The changes in leadership on Capital Hill have dominated the press and media in the last three months. Unlike many on Wall Street, I am a bit skeptical of what the Democrats are capable of accomplishing. As outlined in the most recent post, “Legislative Lay-Up,” we are taking a cautious approach with regard to the impact Congressional action could have on the fortunes of companies in our coverage universe.

Part of our caution comes from a rather jaundiced view on Congress in general regardless of which party is in control of the votes. Capital Hill appears rife with partisanship and nest-lining at the expense of real reforms that benefit citizens.

It is also a bit perplexing how the Democrat Majority is more likely to make things happen now than when the Republicans held the most seats. Republicans got nothing done after six years with control of both legislative branches complemented by a man of their own party in the Oval Office. Such a state of political harmony is theoretically the most conducive to substantive action. (The war in Iraq does not qualify as an example of Congressional action as Democrats and Republicans alike were more or less bullied by Bush’s hegemony.)

In my view, this whole idea of Congressional control is overrated as a portent force in…well, just about anything and especially stock returns. This runs against popular thinking, which holds that equity market performance is better when the presidency, the House and Senate are not controlled by the same party. The logic is that when less legislation gets passed and signed into law, business benefits.

An article entitled “Gridlock’s Gone, Now What?” appearing in the September 2006 issue of the
Financial Analysts Journal describes the work of two professors, Scott Beyer of the University of Wisconsin Oshkosh and Gerald Jensen of Northern Illinois University, and Robert Johnson of the CFA Institute. Their article was written before the November 2006 elections, but the work provides valuable insight into Congressional politics, economic conditions and the stock market.

After examining long-term security returns relative to shifts in the political landscape over the fifty years between 1954 and 2004, the trio found that the popular view “gridlock is good” for equity securities is largely a myth. During the fifty years in the study, equity returns, especially to small caps, tended to be higher and less volatile during periods of political harmony. This suggests that Wall Street should be concerned not encouraged with the Democrats taking over while a Republican is still ensconced in the White House. Worse yet for those focused on small caps, small cap returns tend to lag large caps during periods when party control of the House, Senate and Oval Office were mixed.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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