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.”
Edward Kane has similar thoughts on the subject. Kane, the James F. Cleary Chair in Finance at Boston College’s Carroll School of Management, says “Congress makes news,” and news drives the stock market. But he’s quick to point out that voting proposals into law is not the only–or most significant–news Congress generates.
More information related to business and industry emerges from the activities of Congressional committees, where the debates are focused on which legislation will make it to the floor or which bill provisions will be included or struck from final proposals.
Such ongoing policy discussions that “add or take away advantages” from companies are closely watched by the professional investors who do most of the stock buying, adds Kane.
To make sure the results covered a broad range of companies, as well as a wide swath of time periods, the authors compared the Congressional calendar to returns data from four indexes: the DJIA, the S&P 500, the Center for Research in Security Prices value-weighted (CRSP-VW) index, and the CRSP equal-weighted (EW) index.
Regardless of the index used, the study results were similar. The market did better when Congressmen and Senators stopped working. For instance, the S&P 500 cumulative returns between April 1957 and 2001 were 4.87 percent when Congress was out of session, versus only 2.89 percent when they were in session. For the CRSP VW and CRSP EW (1962-2001), out-of-session returns were 5.69 and a whopping 11.82 percent respectively when Congress was on holiday, compared to a 2.39 percent and 5.93 percent respectively when they returned to work.
The study also found that public opinion plays a role in the Congressional effect. Returns are highest and volatility lowest when a relatively unpopular Congress is out of session. Conversely, says the report, “returns are lowest and volatility highest when a relatively popular Congress is out of session.” (Over the past 40 years Congress has averaged a 39 percent approval rating and a 50 percent disapproval rating.)
In the end, a New York surrogate judge named Gideon J. Tucker might have provided the best explanation of the Congressional drag on the stock market. In 1866 Tucker wrote “No man’s life, liberty or property are [sic] safe while Congress is in session.”