Markets love lame ducks

Next week’s too-close-to-call US presidential election must make a big difference to the way stock and bond markets perform over the next few years — or so you might think. Yet experience suggests that investors should probably stifle a yawn rather than place too much significance on whether Obama or Romney comes out ahead. In practice, markets rarely assign as much importance to the outcome as politicians and their supporters think they should.

For this there are some sound historical reasons. One is that hardly any politician ever succeeds in implementing everything he or she has promised in order to get elected. In the United States, the ability to deliver on promises is additionally constrained by occupants of the White House having to work with a Congress that is often of the opposing political persuasion. However fierce the campaign rhetoric, the checks and balances of the US constitution often produce muddle-through outcomes that party activists hate but markets tend to like. On the rare occasions when a president is given a chance to legislate while his own party has a majority in both the House of Representatives and the Senate, the results can be disastrous.

That’s one reason why, paradoxically, investment returns tend to be better when there is gridlock in Washington. If there is one thing markets instinctively hate, it is politicians coming to power with free rein to introduce ill-thought-out legislation. That’s a reason why markets typically perform better in the third and fourth year of presidential terms, when little legislation happens but promises are two a penny, than they do in the first two years — the narrow window in which newly elected presidents strive to implement their policy commitments. Years dominated by harmless pre-election posturing are relatively less damaging to wealth creators and corporate earnings.