Bloomberg News

Stocks Rising 12% Before Elections Celebrate Budget Impasse

August 01, 2011

(Updates trading in fifth paragraph.)

Aug. 1 (Bloomberg) -- President Barack Obama’s dispute with Congress cost U.S. stockholders $680 billion last week. It may be a clash investors end up embracing, based on more than a century of market history.

The Dow Jones Industrial Average has posted average gains of 12 percent in years before presidential elections since its creation in 1896 and advanced the last 17 times, according to data compiled by Bloomberg and Dow Jones. The 30-company gauge has risen 4.9 percent in 2011, its third-smallest increase at this point of an administration’s third year since the streak of gains began in 1941. It needs to climb another 7.2 percent through the end of the year to match the historical mean.

Candidates seeking re-election typically cut taxes and support measures that boost equities. While the Standard & Poor’s 500 Index fell every day last week on concern the U.S. will default, the combination of Obama’s appeal for a bipartisan solution, rising corporate profits and European efforts to prevent the euro from unraveling may prove to be bullish signs.

“A grand bargain is just the ticket to power stocks,” Howard Ward, who helps oversee $35 billion in Rye, New York, for Mario Gabelli’s Gamco Investors Inc., said in an e-mail on July 26. “With the Fed on hold, Greece off the table and a bipartisan debt deal in Washington, stocks would be the only game in town.”

Agreement Reached

The S&P 500 fell 0.4 percent to 1,286.94 at 4 p.m. in New York today as slower-than-forecast growth in U.S. manufacturing offset Obama’s announcement that leaders of both parties in the House and Senate approved a deal to raise the debt ceiling and cut the federal deficit.

The stock index dropped for a third month in July, its longest slump since 2008, as the U.S. Treasury prepared plans for paying the government’s obligations should Congress fail to raise the borrowing limit. The government will run out of options to prevent a default unless the $14.3 trillion ceiling is increased by tomorrow, Treasury Secretary Timothy F. Geithner has said.

The S&P 500 declined to the lowest level since June after the Commerce Department said July 29 that the U.S. economy grew less than forecast in the second quarter. Gross domestic product climbed at a 1.3 percent annual rate following a 0.4 percent gain in the prior quarter that was slower than earlier reported.

AAA Rating

S&P, which has given the U.S. a top AAA ranking since 1941, said on July 14 that the chance of a downgrade within three months is 50 percent, and a reduction may occur in August if there isn’t a “credible” plan to reduce the nation’s deficit. The S&P 500 slid 3.9 percent last week, the most in a year.

The 12 percent average rally in pre-election years compares with the Dow’s 7.4 percent annual gain since 1896, data compiled by Bloomberg show. The Dow has risen 5.9 percent and 3.8 percent in the two years after the vote, respectively, and 7.5 percent the year Americans select the president.

Advances in the third year of the cycle have been led by companies whose earnings are most tied to the economy, according to data compiled by Bloomberg and Birinyi Associates Inc. That’s in part because government measures stimulated growth, said Linda Duessel, Federated Investors Inc.’s equity market strategist. In 1999 and 2003, technology, consumer discretionary and materials shares posted the biggest gains among 10 groups in the S&P 500. In 2007, energy and materials stocks rose the most.

Intel, Amazon

Intel Corp., the world’s biggest chipmaker, has beaten the S&P 500 in every pre-election year since at least 1983, Bloomberg data show. Seed-company Monsanto Co. and online retailer Amazon.com Inc. posted average gains of 119 percent in 2003 and 2007, compared with the S&P 500’s 15 percent average advance, the data show.

“These three areas are the cyclical areas that would do better if economic activity was doing well,” Pittsburgh-based Duessel said in a July 26 telephone interview. Her firm oversees $354.9 billion. “If our leaders spend money to jump-start the economy, then those sectors would all benefit.”

The S&P 500 gained 26 percent in 2003, the most in five years, after President George W. Bush lowered taxes on dividends and capital gains. It was the start of a 60-month bull market in which the index doubled. Bush was re-elected in 2004.

The biggest yearly rally of the last five decades was in 1995, when the S&P 500 climbed 34 percent, as a debate over federal spending resulted in two government shutdowns. The dispute between House Speaker Newt Gingrich, a Republican, and Democratic President Bill Clinton prompted Moody’s Investors Service to review some U.S. government bonds for a downgrade in January 1996. Clinton was re-elected that year.

Stimulus Spending

This year may be different because the government has run up debt through stimulus spending that may be curtailed, according to Rob Arnott, who helps oversee $75 billion as founder of Research Affiliates LLC in Newport Beach, California.

“If they take spending off the table quickly enough, it creates a major recession,” he said in a telephone interview on July 27. “What the rating agencies are pointing out is if you don’t take spending off the table, you eventually hit a Greek- style wall, and they can’t allow that.”

Government spending may total 25 percent of gross domestic product this year, according to a note last week from Chicago- based Bianco Research LLC. Should the Aug. 2 deadline pass without a deal, that level could fall to 15 percent, according to the research firm.

Fleeing Risk

Although a U.S. downgrade or default would be directly linked to Treasuries, bond markets are signaling investors would flee riskier assets for the perceived safety of fixed income. Treasury yields average 0.72 percentage point less than the rest of the world’s sovereign debt markets, Bank of America Merrill Lynch indexes show. The difference has expanded from 0.15 percentage point in January.

Ten-year Treasuries surged last week, driving yields as low as 2.77 percent on July 29, the lowest level since Nov. 30.

“Treasuries are still the safe haven asset, which creates this perverse thing where you get people buying Treasuries because of concerns that in part stem from the Treasury market,” Russ Koesterich, the San Francisco-based global chief investment strategist for the IShares unit of BlackRock Inc., said in a July 26 telephone interview. His firm oversees $3.66 trillion as the world’s largest asset manager.

Government disputes and federal budget deficits shouldn’t be a primary concern for investors, according to Timothy Ghriskey, the chief investment officer at the Solaris Group LLC in Bedford Hills, New York. He said stocks declined last week because of a lack of clarity on the outcome.

Resolution in 1995

“The debt negotiations and concern about a default in Washington are raising the level of uncertainty in the market, which investors don’t like,” Ghriskey, whose firm manages $2 billion, said in a July 27 telephone interview. In 1995, “once that was over, we ended up being fine,” he said.

U.S. equities are cheaper this year than their historical average during pre-election years, as measured by the S&P 500, even after the index almost doubled since March 2009. The gauge is trading at 14.2 times reported earnings, or 17 percent below the year-end average since 1955, Bloomberg data show. Higher earnings have kept the valuation down, with companies beating analyst estimates for the 10th straight quarter.

A group of S&P 500 consumer discretionary companies is exceeding the index by 3.2 percentage points so far in 2011. Amazon, the world’s largest online retailer, is up 24 percent, more than eight times the index. The Seattle-based company reported second-quarter profit and sales that beat analysts’ estimates after its Kindle e-reader helped fuel growth.

Monsanto, Intel

Monsanto, the world’s biggest seed company, is up twice as much as the benchmark equity index. The St. Louis-based company raised its full-year profit forecast above the average estimate on June 29, boosting the shares 5 percent that day.

Even with the S&P 500’s performance during pre-election years, Santa Clara, California-based Intel has done better, beating the index by 51 percentage points, according to data back to 1983 compiled by Bloomberg. Greater demand for Intel’s chips has lifted selling prices, and the company last month forecast third-quarter sales higher than some analyst estimates.

“Where the third year is concerned, it makes much more common sense that whoever is in a leadership position wants to keep his position and thus will spend a lot of money to make his constituents happy,” Federated’s Duessel said in the telephone interview. “If you let history be your guide, then you would say we should be much higher in terms of the market.”

--With assistance from Inyoung Hwang in New York. Editors: Nick Baker, Chris Nagi

To contact the reporters on this story: Rita Nazareth in New York at rnazareth@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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