Hat tip goes to reader Jeff for pointing to “Of babies and hammers:”
The stock market will get a major boost at the end of this week. That’s when Congress’ August recess begins, and it isn’t scheduled to go back in session until after Labor Day.
What’s that have to do with the market? Plenty, apparently. The stock market on average has performed much better when Congress was not in session.
Consider an academic study several years ago by professors Michael Ferguson of the University of Cincinnati and Hugh Douglas Witte of the University of Missouri at Columbia. Specifically, they found that “about 90% of the capital gains over the life of the Dow Jones Industrial Average have come on days when Congress is out of session.”
Specifically, according to the professors, the Dow between 1897 and 2004 produced an annualized return of 5.3% when Congress was out of session, in contrast to just 0.4% when it was in session.
It’s always possible, of course, that this so-called “Congressional Effect” is just a statistical fluke. Correlation is not the same as causation, after all.
But the professors don’t think it is just a fluke. Companies and investors face “a more uncertain tax and regulatory environment” when Congress is in session, which means risk is higher then than when Congress is on recess. As confirmation of this finding, the professors point out that the stock market has tended to exhibit significantly greater volatility when Congress is meeting. And volatility is a good proxy for uncertainty.
The professors quote from a famous speech of Will Rogers in 1930: “This country has come to feel the same when Congress is in session as we do when a baby gets hold of the hammer. It’s just a question of how much damage he can do with it before we take it away from him.”
Another reason why the professors don’t think their results are just a fluke: The pattern has tended to be strongest when Congress has a low approval rating in public opinion polls. For example, they found, the Congressional Effect has tended to be especially pronounced whenever Congress’ overall approval rating is below 39%.
This particular wrinkle in the data suggests the market may receive more than the usual boost during Congress’ upcoming recess. Among the several polls that PollingReport.com reports as having been conducted over the last six weeks, Congress’ current approval ratings range between just 19% and 24%.
One general investment lesson that can be drawn from this academic study is that the stock market is very sensitive to factors that we might not otherwise think have much to do with it. In this case, it means that, in order to understand the stock market, we have to also understand what’s going on in Washington.
[Emphasis added]
I must admit that Will Rogers’ quote gave me a big chuckle. In regards to congress being out of session, I feel the same in that at times it’s better/safer doing nothing than coming up with something stupid.
In terms of investments, the major trends just happen to be up, so if that theme continues, further market gains may very well coincide with congress resting, however, the absence of congressional sessions will not have been the cause of it.
Nevertheless, it’s interesting that this study ranging over 100 years has produced these types or results especially when considering that these gains have come during the stock market’s notoriously slow summer time as opposed to the traditional strong period from January through April.
Time will tell if this phenomenon will “assist” the markets this year. My focus will be obviously on trend direction along with our trailing sell stops. If congressional absence should lend a hand in the bullish cause, then I will take this simply as a bonus.