Preferably, It's All or Nothing

Historically, stock prices have performed best under a unified Congress -- of either party

The mid-term elections are upon us. Control of the Senate and House of Representatives is up for grabs. Even though the Democrats may take control of the House, the odds are long for a total sweep. But as Harry Truman proved in 1948, anything is possible.

Currently, the Republicans control both the executive and legislative branches of the U.S. government. So the obvious question is: What happened to stock prices when one party surrendered partial or total control of Congress? This scenario has occurred six times since 1945 - twice to Democratic presidents and four times to Republican chief executives. Interestingly, Wall Street responded favorably to the change, with the S&P 500 posting an average price advance of 4.8% during November and December of those years (five of the six times, the S&P 500 had a gain for the year). Remember, however, that what worked in the past may not work again in the future.

So, what can investors expect in 2007?

Next year marks the third year of President Bush's second term in office. Historically, stock prices have posted their best performances in the third year of the presidential cycle, rising an average of 18% since 1945 vs. an average of 9% for all four years. What's more, third-year advances have been very consistent, as the S&P 500 climbed 93% of the time (the market was flat in 1947). The last time the "500" declined in the third year was 1939. The fourth year's 8.6% average increase is second highest.

One reason for this stellar performance could be that Wall Street anticipates that the party holding the presidency will attempt to maintain it by introducing economically stimulative legislation in the third year that will spur growth. Such action could put additional dollars into voters' pockets just as the fourth year's Election Day rolls around.

The table below offers a better feel for the market's performances under different political scenarios - political unity (presidency and both houses of Congress controlled by the same party), partial gridlock (Senate or House of a different party), or total gridlock (both houses of Congress controlled by the opposite party of the president). Also shown is the S&P 500's performances under these scenarios during a third term in office and during a Republican presidency.

The S&P 500 posted better returns (and frequency of advance) during periods of political unity, but surprisingly strong results under the total gridlock scenario. The periods of partial gridlock, which were relatively rare, saw the weakest market returns on average.

When Republicans controlled the presidency, Wall Street favored political unity over total gridlock by a more than a two-to-one margin. Of course, total gridlock has occurred much more frequently.

There are not enough third years of Republican presidencies, let alone third years of second terms, to make the results statistically convincing.

Since the stock market has performed well during periods of both political unity and total gridlock, the conclusion we draw is that either Wall Street doesn't care who is running the government, instead focusing more on the Fed and fundamentals, or it dislikes disunity and would prefer to see a unified Congress -- regardless of the party.

S&P 500 % Changes During Periods of Political Unity and Gridlock 1945-2006
  Political Unity Partial Gridlock Total Gridlock All Years
All Parties (1945-2006) 10.20% 3.50% 9.40% 9.00%
Number of Years 26 8 28 62
% up years 77% 63% 75% 71%
All Parties (3rd Years) 18.80% 17.30% 17.70% 18.00%
Number of Years 5 1 9 15
% up years 100% 100% 89% 93%
Republican President        
(All Years) 14.50% 3.50% 7.10% 7.60%
Number of Years 6 8 20 34
% up years 83% 63% 70% 71%
Republican President        
(3rd Year) 26.40% 17.30% 17.60% 18.70%
Number of Years 1 1 6 8
% up years 100% 100% 100% 100%
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