A Capitol Effect on the Capital Markets

The stock market responds poorly when Congress is hard at work, a new study finds. But the reason for those down markets is a mystery.

While Congress is away, the bulls will play. At least that’s what the authors of a new study, “Congress and the Stock Market,” conclude: Stock market returns are lower and more volatile when Congress is in session than when it’s in recess.

In fact, about 90 percent of capital gains recorded on the Dow Jones Industrial Average (DJIA) index between 1897 and 2001 occurred on days when Congress was not is session, according to the study.

Put another way, if a dollar was invested in the DJIA in 1897 using an “out-of-session” investment strategy, by 2001 it would have grown to $216 (excluding dividends and transaction costs for simplicity’s sake). That same investment would have yielded only $2 using an “in-session” investment strategy, note finance professors Michael Ferguson of the University of Cincinnati and H. Douglas Witte of the University of Missouri, Columbia, who authored the study.

The research project has been brewing in one form or another for about 10 years. Ferguson asserts that the “Congressional effect” is stronger than most other non-financial stock market hypothesis. That includes the so-called “weather effect” that holds that cloudy weather translates into lower-than-usual stock market returns because investors’ moods are sullen, he says.

The weather effect, which for the most part has proved to be correct, affects the stock market by 1 to 2 basis points per day, according to Ferguson. The Congressional effect is twice as strong, usually affecting the market by 2 to 4 basis points daily. Ferguson says that although that’s not a big change for any one day, “over a year’s time it adds up.”

For the period that the study covers, Congress had been out of session an average of 116 trading days per year for the 105 years since the DJIA was established. For the 39 years that the Center for Research in Security Prices (CRSP) index had been in operation (an index the study also uses), Congress averaged 80 days out of the office.

Ferguson stands squarely by his study results. He notes that the data has been run through Monte Carlo simulations and other models. It’s also been controlled for previously documented seasonal market events like the pre-holiday and post-holiday weeks, during which time the market is usually somewhat higher; Mondays, when share prices are usually a bit lower; Fridays, when shares are relatively higher; and for the last trading day of the month and the first three days of the month, when share prices often rises relative to the rest of the month.

What Ferguson isn’t so sure of is how to interpret the Congressional effect. His best guess is that Congress is a proxy for regulatory uncertainty, which historically has squelched market returns. To be sure, when Congress is in session, often debating and passing laws that affect industry, investors are scared off by the uncertainty that accompanies potential regulation or newly-signed legislation.

Ferguson cites Burton Malkiel’s 1973 landmark investment strategy book, A Random Walk Down Wall Street to make his point. In the book, Malkiel contends that “[I]t is not so much the direct cost of regulation that has inhibited investment but rather the unpredictability of future regulatory changes.”


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