We like anomalies, especially anomalies that few know about. Finding a big, fat, unknown anomaly in stock markets is a great way to know something others don't and make a big bet. Well…
…2007 is a third year of a Presidential term: the sweetest for stocks. And no one is talking about it.
The State of the Union speech is one of the biggest days of the year in the US for political rhetoric. The President sets his agenda for the year and everything abounds with pomp, ceremony, and tradition. Politicians smile and tell us all about how much they're going to do for us in the coming year.
For full coverage on all things said and promised, including the text of the speech:
Complete Coverage: The State of the Union
The New York Times
But we don't think of anything will get done. Currently, Congress is controlled by the Democrats: the Senate is almost dead even, the House is divided by just a handful of seats, we have a lame duck President with low job approval ratings, and an upcoming Presidential Election in 2008.
All this adds up to what we call "nap time" in Congress. Sure, they'll be a great deal of talk, but not much will happen. Big legislation is polarizing—and that's the last thing Congress wants to do to voters heading into the 2008 elections. Mostly, they'll play nice with each other and not try anything too drastic.
This was made abundantly evident in President Bush's speech last night, which opened with profuse congratulations to Speaker Pelosi and the Democratic mid-term victory, and proceeded to address a number of issues important to the Democratic party. The hard line GOP policies were nowhere to be found.
Add in the fact that things are very tight in Congress, and it becomes evident not much will happen over the next two years in terms of major legislation. It's going to be a do-nothing Congress for the most part. They'll be lucky to agree on what color the curtains should be.
Why's that important? Two reasons. One, we love do-nothing Congresses because they do nothing. Anytime you can just let the private citizens go about their business and not bother them—tremendous prosperity tends to ensue.
Secondly, and most important—a "napping" Congress is a great backdrop for stocks in a President's third year.
The third year of a US Presidential term is usually characterized by waning political risk aversion as the President's party commonly loses seats in Congress during the mid-term elections. Markets abhor legislative changes and prefer political stasis in the short term. Mandated changes in wealth distribution create both winners and losers. Because people hate the prospect of a loss about 2.5 times more than an equal sized gain, shifts in private property rights, taxes, or entitlements have a net negative effect. Since we believe the potential for such major economic regulation is unlikely, the benign election outcome points to a highly favorable political environment for stocks.
Since 1927, there have been 20 Presidential term 3rd years. 18 of those have been positive. The median return of the S&P 500 in those years? 23%. This is by far the most positive year for stocks in the cycle both in number and magnitude. And this theme works for global stocks, too.
As we've explained, the typical favorable aspects of the third year are indeed in place for 2007. So while everyone is getting excited for all the political buzz after the President's speech—we're excited for much different reasons. The Presidential term third year anomaly is here, the sweetest for stocks.