Undoubtedly, US politics will be on folks’ minds throughout 2008 and will have implications for stock markets. 2008 is the fourth year of a US presidential term—historically very positive for stocks globally. And, as politicians busy themselves with campaigning prior to November’s elections, Fisher Investments is confident Washington will again prove legislatively feckless. We think feckless is good in this department.
As always, Fisher Investments remains agnostic to political affiliation. We believe siding with one party or another creates harmful biases clouding investing judgment. Thus, Fisher Investments favors neither side in our analyses and attempts to be as objective as possible.
Presidential Fourth Year
Republican or Democrat, the fourth year of a president’s term has been good for stocks. In fact, the S&P 500 returns 14.0% on average during presidents’ fourth years. This is largely because politicians rarely pass major legislation during this period due to the reduction in power their party typically experiences in the mid-term elections. This cycle is no exception. Stock markets abhor the risk of wealth and property rights redistribution inherent in legislation, which causes heightened uncertainty and investor risk aversion. Much like last year, a gridlocked and inactive Congress means less legislative uncertainty for markets. Presidential term fourth years are consistently positive for stocks with only a few exceptions.
2008 Election Outlook
It’s still far too early to forecast November’s election outcome. 2008’s presidential election is the weirdest in our memory. For instance, most primaries this year will occur nearly six months before party conventions. But that doesn’t mean we’ll know the nominees any earlier than in the past. In fact, the nominees could be undetermined all the way up to the conventions. This is due to the closeness of the races on both sides and the extremely complex systems each party uses to compute delegates.
As an example, let’s look at the Democrats. On February 5th, about 1,700 Democratic delegates will be at stake. But candidates need at least 2,025 to secure the nomination. With two strong candidates, the delegates are likely to be divided fairly evenly because the Democrats award their delegates proportionally in each state, not winner-take-all. But even if Senator Clinton or Senator Obama won every delegate that day, it still wouldn't be enough to get the nomination.
It gets even more complex. The real wild card for the Democrats has to do with “superdelegates.” These comprise nearly 800 elected officials and members of the Democratic National Committee who are free to support any candidate they choose at the national convention, regardless of the primaries. It could come down to their support at the convention come August. Senator John Edwards has dropped out of the race but declined to endorse either candidate for now. He stands to play the role of “king-maker” by directing delegates pledged to him and will thus garner much media attention and courting from both Democratic candidates.
The Republican delegate system is just as murky. However, since most Republican states handle delegates in a winner-take-all format, a conclusive nominee is more probable with the Republicans than the Democrats.
At the very least, contrary to early prognostications, the campaign on both sides could continue well past Super Tuesday. This uncertainty carries a realistic probability of a third candidate entering the fray. It’s extremely rare to have a sitting senator ascend to the presidency (only JFK and Harding in the last 100 years), but this year it’s possible one will be nominated from both parties. Senators are often viewed as weak candidates because they have little executive experience. This opens the possibility for Michael Bloomberg, mayor of New York City, to enter the race as an Independent. Unlike Ross Perot in 1992, who faced two strong candidates including a sitting president, Mayor Bloomberg could be a winning candidate. With his billions, he has enough money to easily outspend both candidates three-to-one.
All of this contributes to further uncertainty about the ultimate outcome. It’s impossible to know right now. Either way, the degree of uncertainty tied to the elections will matter for stock returns this year.
Election years where the outcome was less certain (or, years when the ultimate winner garnered a smaller percentage of the total vote) result in middling stock market returns. Conversely, when the outcome was a landslide (or, more certain) stocks moved nicely higher.
Note also the reverse is true for the following inauguration year. That is, when the outcome was uncertain in the election year and returns were tepid, stocks tended to perform relatively better the following year. Years when the outcome was surer produced a nice return in the election year, but less so in the year following. (Source: Thomson Datastream and Standard & Poors.)
In Fisher Investments’ view, the key to this phenomenon is understanding how folks perceive the winning candidate’s party. It’s typical to believe “Democrats will be bad for business and be free spenders,” while “Republicans will restrict the budget and be friendly to business.” Neither ends up true in practice—neither donkeys nor elephants make good on campaign promises very often. Nevertheless, folks worry over Democrats ruining business in the year of the election, only to find out in the inauguration year it won’t be as bad as feared. Conversely, folks believe a Republican will be good for business (and thus stocks), only to find out in the inauguration year it won’t be as good as hoped.
But no matter what happens in November, a change in leadership isn’t historically bad for stocks. If you fear a Democrat taking the White House, you shouldn’t. From 1928 to present, White House changes from Republican to Democrat averages a 5.8% return for the S&P 500 in the election year and 20.7% in the inauguration year.
Many fear a Democratic sweep of the White House and Congress. It is possible the elections could produce the most heavily Democratic administration change since FDR was elected. But, should a Democratic sweep occur (and we certainly are not making such a prediction just yet), it’s unlikely to be lopsided as the Democratic majority was with LBJ after 1964. In that time the Democrats had 295 in the House versus 140 for the GOP, and the Senate had 68 Democrats versus 32 Republicans, a filibuster-proof and veto-proof Senate. No matter what happens in the 2008 elections, Fisher Investments believes it’s unlikely anything quite so extreme will occur. And 1964 and 1965 were perfectly fine for stock markets: 16.4% and 12.4%, respectively. (Source: Global Financial Data.)
In the months ahead Fisher Investments will provide further extensive analysis. But for now, our approach is “wait and see” as the primary election dust settles.
*Written as of February 06, 2008. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.