The folly of political portfolios.

The folly of political portfolios.

The folly of political portfolios.

Moneybox
Commentary about business and finance.
May 24 2008 6:43 AM

Market Botch

The folly of political portfolios.

John McCain. Click image to expand.
John McCain

It's that time of the leap year. Personal-finance magazines and investment analysts are constructing political portfolios: market sectors or stocks that will thrive, or dive, should a particular candidate take the White House. Like party conventions, these portfolios are a storied component of the campaign season. Like party conventions, they're not very useful or illuminating. Trust me. I know from experience. In October 1992, a younger, svelter version of this columnist called analysts to find out which stocks would do well if Bill Clinton were to beat George H.W. Bush.

The response: Clinton's proposals for a stimulus package and a Rooseveltian Rebuild America Fund would be a gold mine for construction-equipment makers like Caterpillar. A Salomon Brothers analyst said Clinton's universal health care plan, a pet project of his wife (plus ça change), would be great news for HMOs. But the stimulus package and universal health care were among the early casualties of the tumultuous Clinton first term. Likewise, analysts argued in the fall of 2000 that a George W. Bush victory would light a fire under the already soaring stocks of Microsoft and MCI WorldCom. Why? Bush would likely be more lenient on antitrust policy. As CNBC's James Cramer would say: "Wrong!" (Microsoft's stock is below its level of January 2001) and "Wrong!" (MCI WorldCom went bankrupt in July 2002).

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Political market calls are conceived in sin, since most are based on the false premise that the stock market prefers Republicans to Democrats. According to Sam Stovall, chief investment strategist at Standard & Poor's Equity Research, between 1945 and 2007 the S&P 500 rose 10.7 percent annually when Democrats occupied the White House, compared with a 7.6 percent annual increase under Republicans. Those who, fearing higher taxes, sold stocks after Bill Clinton's inaugural missed out on a great rally. And those who, anticipating lower taxes, plunged into the market in January 2001 entered what has been a lost decade for U.S. stocks; since 2000, the markets of countries like Brazil and China have lapped their American cousins.

Political portfolios also rely on a similarly simplistic understanding of how Washington works. Analysts seem to believe that political platforms are fail-safe guides to What Will Happen. Bill Clinton's 1992 platform said there would be no capital-gains tax cut for the wealthy on his watch. (He signed one in 1997.) Bush's 2000 platform vowed that "the Social Security surplus is off-limits, off budget, and will not be touched." OK, then. The portfolio makers also seem to assume that once presidents take the oath of office, they remove a magic wand from a special case in the Oval Office and conjure campaign promises into policy instantaneously—without congressional input.

Wall Street types might be forgiven for not comprehending the byzantine path that legislation treads on Capitol Hill. Less forgivable is the way political portfolio construction misunderstands markets. Ultimately, megatrends far beyond the control of government—like the Internet or the growth of China—influence stocks more than small-bore policies. The Medicare prescription-drug benefit, passed in 2003, was seen as a huge boon to Big Pharma. But since the benefit was signed into law in December 2003, the Amex Pharmaceutical Index has woefully underperformed the S&P 500. "Pharma is in the midst of a bad research and development cycle, and Pfizer hasn't had a major new drug," said Les Funtleyder, health care strategist at Miller Tabak.

Even when they're right, politically inspired stock recommendations are often right for the wrong reasons. Oil stocks have done well under the Bush-Cheney administration, as analysts suggested in 2000, but not because the former oilmen made good on campaign promises to open up the Arctic National Wildlife Refuge for drilling. Instead, ExxonMobil has soared because breakneck growth in China, tensions in the Middle East, the weak dollar, and speculators have pushed oil higher.

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This year, Dan Clifton, the Washington-based head of policy research at Strategas Research, is taking political/stock analysis to a new level by looking at the makeup of Congress. "Reps. Charlie Rangel and Barney Frank will have a say in tax bills, no matter who is elected president," he says. Clifton's Democratic Sweep portfolio, which assumes Democrats win the White House and 60 seats in the Senate, suggests buying an alternative-energy fund and shorting utilities stocks (since increasing the dividend tax, as a President Obama might do, would eat into the value of these dividend-paying stalwarts). Sam Stovall of S&P argues, counterintuitively, that a Democratic president would be better for oil stocks. Why? If a Republican president advocates drilling in ANWR, Congress will accuse him of helping oil-rich friends. "But if the proposal comes from a Democrat, Congress might be more likely to go along."

That's plausible. But it's just as plausible that a massive new find in Canada or a recession in China will roil the oil markets more than anything President Obama or President McCain will do.

Still not convinced of the folly of political portfolios? Consider this: In the fall of 2000, the Platonic ideal of a Bush-era stock would have been based in Texas and involved in energy distribution and trading, would benefit from deregulation in power markets, and would have a CEO with a Bush-bestowed nickname, say "Kenny Boy." And that would have been Enron.

A version of this article also appears in this week's issue of Newsweek.