It is not often that I say this after decades of making a living from financial markets, but right now the stock market has me befuddled. We seem to be bouncing around in response to every headline, and even tweet, with traders and investors seemingly unable to decide what is important.
There have been negative reactions to talk of trade wars, the situation in Syria, and data that suggests the Fed will raise rates quicker than previously thought.
However, each time one of those fears fades from the headlines, we bounce back on strong fundamentals. There does seem to be one thing that is largely being ignored: politics.
That is understandable as all but the most partisan of hacks has surely become tired of the mudslinging on both sides of the aisle, and the lower the level of discourse sinks, the less relevant to the market and the economy it seems.
Still, the fact that the sitting President and his campaign team are under an investigation that has already led to four guilty pleas suggests that there is some substance under the surface pettiness, and if so one would think there must be implications for the market. That prompts an obvious question: does the political crisis towards which we are heading matter for stocks, and if so what reaction should we expect?
By instinct and training, my reaction when faced with a question like that is to seek out the data, and we have two similar situations to look back on. Richard Nixon and Bill Clinton both faced scandals that led to impeachment proceedings. The outcomes were different, with Nixon being forced to resign and Clinton being found “not guilty” in the Senate, but both were major political crises.
Looking back at the market during each of those times should give us a clue what to expect as the current affair drags on, but the data are distinctly unhelpful.
From the time that the Watergate burglars were indicted in September of 1972 until Nixon resigned in August of 1974, the S&P 500 lost a whopping 52%.
By comparison, from the time the Clinton/Lewinski scandal became public in January of 1998 until impeachment proceedings were concluded around thirteen months later, the market reacted completely differently, gaining close to a third.
There could be several explanations for that. Some would say that it was to do with party affiliation. Nixon was a Republican and Clinton a Democrat. The traditional free-market, pro-business policies of the Republican Party mean that Wall Street is predisposed to prefer Republicans in power, so the prospect of a scandal that virtually ensures a Democratic wave at the next election was much scarier to traders and investors than the opposite.
There may be some truth to that, but policies and cyclical economic factors have a much larger impact on stock prices than the party affiliation of the White House and Congress. Lest we forget, the S&P 500 tripled under Barack Obama, so obviously market performance is not all about which party is in control.
That leaves us with the underlying economic conditions, and from that perspective the early 1970s and late 1990s were very different times.
In 1972 the U.S. economy was heading into a crisis. The oil embargo and other factors created an inflationary environment that in turn led to the economy officially being in a recession beginning in November of 1993, which saw unemployment jump from around 4% to 9%. In the late 1990s we were, by contrast, in the midst of the dotcom boom and in an expansionary part of the economic cycle.
The obvious conclusion here is that the market is ignoring the current political upheaval and the potential for a full-blown crisis for a reason. Even if it turns out to be politically explosive, it will probably not be particularly relevant to stock prices. I have said on many occasions that investors should do their best to ignore scandals and headlines and focus on the current economic situation and outlook and on corporate profitability, and that advice is backed up by an analysis of past political crises.
So, as we continue to see strong earnings and encouraging data, the only logical assumption is that whatever the outcome of the Mueller investigation, the raid on Michael Cohen, and all the rest, the market will continue to do its thing regardless. If that means that we can ignore the tawdry details and personal insults that are so common now, then I for one am grateful.