May 23 (Bloomberg) -- Washington is awash in scandals. The White House is fending off inquiries on three fronts: its response to the terrorist attack on a U.S. diplomatic outpost in Benghazi; the Internal Revenue Service’s scrutiny of conservative groups seeking tax exemptions; and the Justice Department’s broad seizure of Associated Press phone records in a leak probe.
Democrats in Congress are outraged -- by the IRS scandal, at least -- and don’t want to look blase about an organization everyone loves to hate when control of the Senate is at stake in the 2014 midterm election. Republicans smell blood. No fewer than five congressional committees have announced hearings to investigate the Benghazi and IRS scandals. They could drag on for months. A special prosecutor may get the nod.
All of this distraction is surely bad for the U.S. stock market and economy, right?
To the contrary. “Do-nothing Congress” may originally have been a pejorative term directed at the 80th Congress by President Harry Truman. (The last Congress, the 112th, put Truman’s to shame.) For investors, it means something entirely different: better returns.
Several analysts have observed that the stock market tends to do better when Congress isn’t in session. Eric Singer, manager of Congressional Effect Management, has made a career of, and written a book on, just such an effect. Jim Bianco, president of Bianco Research LLC, has studied the relationship between the number of pages in the Federal Register -- the government’s “rule book” -- and bond and commodity markets. He found that more pages yield less profit.
So what’s behind the idea of legislative risk? I called Singer to find out why the market tends to outperform when Congress isn’t in session.
“There are 535 men and women who wake up each day trying to become an ‘issues entrepreneur’ by championing legislation,” Singer said.
To the extent that Congress is distracted by scandals, it should limit legislative initiatives. But the surest way to capture the congressional effect is to be invested only when Congress is out of session, Singer said. His mutual fund invests in the Standard & Poor’s 500 Index when Congress is out of session and is hedged or in cash equivalents when it’s in session.
Such a strategy would have paid off handsomely in the last 115 years. One dollar invested in the Dow Jones Industrial Average in 1897 during in-session days would have compounded to $2 at the end of 2012, Singer said. The same dollar invested during off-session days would have appreciated to $300. These statistics measure price change only.
The congressional effect would seem to apply to the overall economy, as well. To the extent that Congress writes rules and regulations that curtail businesses’ freedom, impose additional costs and interfere with the voluntary exchange of goods and services, lawmakers prevent the economy from reaching its potential.
Throw in the government’s predilection for trying to pick winners and losers -- for subsidizing socially responsible projects that yield financially unsustainable businesses -- and it isn’t hard to understand the legislative effect, or curse, as it turns out. Heck, the economy might have done a whole lot worse if the 112th Congress had done something, instead of nothing.
You can have too much of a good thing, however. While the early stages of a scandal tend to be bullish in that they prevent congressional overreach, “it can morph into something else,” Bianco said. “There’s a fine line between a distracted Congress and a government that can’t function properly,” which leads to a loss of confidence on the part of the public.
A case in point is Watergate. The investigation by both the press and Congress captivated the entire nation as it gradually ensnared President Richard Nixon’s top advisers and ultimately led to the Oval Office. With the economy mired in what at the time was the worst recession since the Great Depression, Nixon’s resignation on Aug. 9, 1974, didn’t halt the decline in the stock market, which fell an additional 25 percent by year-end. Which just goes to show there are exceptions to every rule or investing strategy.
Congressional committees are still engaged in a fact-finding mission on what looks like an abuse of authority by the IRS. If the hearings produce evidence of impropriety on the part of the White House, they will definitely interfere with Obama’s second-term agenda, including immigration reform, gun control and an overhaul of the tax code (don’t hold your breath on the last one).
That’s not all bad for Obama, who is into legacy-planning. He may have inherited a lousy economy from his predecessor, but he can’t very well leave office after eight years and blame George W. Bush for tepid growth in both terms. Counterintuitive as it may seem, Obama should hope the scandals distract Congress from its legislative agenda since any diversion suggests a better economy and stock market. Unless, of course, the scandal trail leads to him.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg View columnist. The opinions expressed are her own.)
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