It's been said that political gridlock may be bad for the nation, but it's good for the stock market. Before we tackle whether this popular saying is true, let's examine the stock market's performance.
Since the beginning of the year, U.S. stocks have enjoyed impressive gains. The S&P 500, Dow Jones Industrial Average, and Nasdaq Composite have all gained more than 19%. That's a better return than most other investment categories, including emerging markets (EEM), bonds (AGG) and gold (GLD).
But as we head into the final quarter of the year, President Obama and Republican congressional leaders are locked in a battle that could lead to a government shutdown or debt default. How will the market react?
During 2011, the debt ceiling fight (political gridlock) between U.S. politicians, shook the S&P 500 stock index (SPY) to a 16.58% decline from Jul.22 to Aug.8. (See chart below) The Aug.8 date was the first day of trading after the U.S. government's credit downgrade by Standard & Poor's from AAA to AA+. Although stocks (SCHB) gained 12% thereafter, the S&P 500 ended the year basically flat.
Since the federal debt limit was raised to $16.69 trillion in May, the U.S. Treasury has been using "extraordinary measures" to avoid defaulting on the nation's debts. By mid-October, these extraordinary measures will be completely exhausted unless Congress steps in.
Thus far this year, the VIX, which measures stock market fear or volatility (CBOE:^VIX), has experienced a sudden spike roughly every two-months. On June 20, the VIX (VXX) hit a yearly high of 20.49.
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President Obama's approval rating is currently 44%, according to Gallup's latest poll. The Dow Jones Industrial Average (DIA) has gained 12.3% over the past five decades proceeding Obama's first term, when presidential approval ratings hover between 35% to 50%, according to Ned Davis Research.
As presidential job approval ratings sink, so do stock market returns. When approval ratings fall between 50% and 65%, the Dow had an average annualized gain of just 5.4%. President Obama's low point in approval ratings was 38% from Oct.15-17, 2011.
The average approval rating for U.S. presidents over the past 75 years is 54%.
Contrary to conventional wisdom, political gridlock is not always good for the stock market - especially when it involves the potential for government debt defaults and other bizarre scenarios that our generation has never seen or experienced.
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