The Road Ahead

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US Stocks Under Different Administrations (1871 – Present)

(Source: Global Financial Data)


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Young America in Wall-Street (1857)


Sunday Reads

Not that the Summer of 2020 was a particularly stellar one, what with a global pandemic and all… but in the stock market, Summer was pretty good to major indices:

That said, I don’t think I’m alone in feeling like the last few weeks have felt markedly different than July and August in terms of general sentiment and headlines.

Since September 2nd, the major indices have lost their summer mojo.

I like the way Michael P. Regan summed up this stark shift:

There are a few jokes going around Wall Street to explain the wild ride for the U.S. stock market this summer: Why did the huge rally suddenly stall out on Sept. 2? Because all the phone-app day traders had to go back to school. Or maybe because the NFL season (and football betting) was approaching.

It’s no surprise that professional traders—hardly paragons of rationality—would point to ordinary investors when things get weird. But it’s true that there seems to have been more driving the Covid-era bounce than rate cuts and government stimulus. The rise of commission-free trading, the ease of fractional share ownership, and maybe the gloomy-giddy feeling that there’s nothing better to do fueled a new public fascination with the stock market. Retail traders now account for 20% of equity trading, up from 15% last year, according to an analysis by Larry Tabb of Bloomberg Intelligence.

So perhaps the end of summer and the easing of pandemic lockdowns really did have some psychological effect, contributing to the 5% slide in the S&P 500 since the recent high.Whether you’re a teacher, a restaurateur, gym owner, or even a sports handicapper—September comes around, you’re probably going to return to your day job,’ says Julian Emanuel, chief equity and derivatives strategist at the brokerage BTIG. ‘So your focus on trading the market is, by definition, going to diminish’.”

I also think that the market and investors are paying greater attention to the Election taking place in roughly 6 or 7 weeks, and acknowledging just how contentious the event will be. Add in a pandemic to an already testy affair, and we are set for some volatility. This divisiveness will only be exacerbated by the debate around how to handle the Supreme Court Justice nomination.

Yet, most people’s primary fears for the election seemingly relate to be the prospect of a contested election due to mail-in voting complications. The concerns center on how our country and the losing side will be equipped to handle such an outcome. Unsurprisingly, I turned to the annals of history to see what happened the last time the world had to mask up and social distance: 1918.

Spanish Flu & The 1918 Election

From the masked voting requirements to the impact on campaign trails, the 1918 mid-term elections during Spanish Influenza are eerily similar to the conversations surrounding our upcoming election in 2020.

Due to similar bans on gatherings and social distancing requirements, the typical political campaign in 1918 was upended as politicians could no longer hold their standard rallies and events. With no technology to easily reach their supporters like we have today, this totally changed the game for politicians.

And of course, the pandemic was politicized… Jason Marisam wrote:

In at least one instance, there were charges of political malfeasance in local officials’ decisions to ban public gatherings. In New York, Democrat Alfred Smith—looking to shore up last minute support in his bid to unseat Republican Governor Charles Whitman—accused local Republican officials of enacting bans in upstate cities to prevent him from campaigning there. He was quoted in the New York Times as saying:

‘A meeting had been scheduled for the City of Hornell on Monday Night, Oct. 21, and in spite of the fact that there is little evidence of the epidemic in that city, as the schools, churches, and places of amusement are open, the Board of Health or the local health authorities, all Republicans, met last night and declared against our meeting, but left all other gatherings alone. The [Democratic] headquarters at Syracuse is in possession of reliable information that their action was prompted from high Republican circles…

Of course, I have no intention of addressing meetings in localities where my doing so might involve a menace to the public health, but this idea of stopping meetings on the ground that the epidemic might strike a town by the time I get there as the Hornell authorities did, seems to me far fetched enough to justify suspicion that they want to prevent the spread of  Democratic doctrine rather than the spread of Spanish influenza.

Ultimately, almost all of Smith’s upstate speaking schedule was abandoned due to localities’ bans on public gatherings, leading one Democratic leader to characterize the situation as ‘the Republican quarantine against Democratic campaign speeches’.”

In a funnier anecdote, apparently whiskey distillers were trying to push the narrative that liquor cured Spanish Influenza in an attempt to curry favor and repeal prohibition at the polls.

“As Election Day approached, activist groups relied on issues-based appeals to encourage voting, even as the pandemic spread.

Alcohol prohibition was on the ballot in at least eight states in 1918, and temperance activists like the Muskingum County Dry Federation in Ohio’s The Times Recorder accused the liquor industry of trying to profit off the ‘suffering and deaths of human beings’ because of the flu. ‘They are industriously circulating reports everywhere that whiskey is a cure for the great influenza epidemic,’ the group argued in the paper.

Prohibition opponents bought a full-page ad in Florida’s The Tampa Times and declared, ‘liquor has saved many a life recently in this terrible epidemic of Influenza,’ citing reports of the use of liquor in ‘alcohol baths’ for Iowa flu patients and as stimulants for sick military men in Camp Lee, Virginia.”

When it came time to actually vote, turnout was 10% lower than the previous mid-term election in 1914, although the First World War obviously had a key role in decreased turnout. Regardless, it is interesting to see the similarities in voting experiences between 1918 and 2020:

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If you’re interested in reading more on this, check out this article: Judging the 1918 Election.

So What?

I think that the election’s effect on the stock market has been an underappreciated event so far, especially given that this year’s election will be one of the strangest since 1918 in terms of process. Among other things, I think the role of politics / elections is worth revisiting in today’s post as a reminder that the markets this summer are not indicative of what’s to come.

Let’s dive in!

Going to Extremes: Politics After Financial Crises (1870 – 2014)

There is no shortage of political divisiveness and anger in the United States. Add in a recession and global pandemic? We’re in store for a political nightmare and the presidential election is fast approaching. Remember that whole thing?

This article provides helpful context on the historical relationship between political movements and financial crises / market crashes. Across 20 developed countries, this paper assesses the political consequences of financial crises over the last 140 years through studying more than 800 general elections. Their analysis finds that ‘On average, far-right parties increase their vote share by 30% after a financial crisis.’

Equally interesting is their conclusion that only Financial Crises have this large impact on the political process:

‘Financial crises are politically disruptive, even when compared to other economic crises. Indeed, we find no (or only slight) political effects of normal recessions and different responses in severe crises not involving a financial crash. In the latter, right wing votes do not increase as strongly and people rally behind the government. In the light of modern history, political radicalization, declining government majorities and increasing street protests appear to be the hallmark of financial crises.’

In so far as people blame central banks for exacerbating inequality through quantitative easing, the authors end their article by acknowledging this argument:

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‘As a consequence, regulators and central bankers carry a big responsibility for political stability when overseeing financial markets. Preventing financial crises also means reducing the probability of a political disaster.’

The Market Impact of US Presidential Elections

Winton Capital are known for their excellent historical insights, and this has to be one of their best (and most relevant). Their research looks back at the market’s reaction to presidential elections, beginning with President Grover Cleveland in 1884.

What’s really interesting is the chart below, which plots a President’s margin of victory, and the market’s returns in the previous 90 days:

The article proceeds to state:

“The cliché that Republicans are good for business/Wall Street and Democrats are the party of labour has been off the mark for a long time but still persists. It has been well documented that equity holders have enjoyed excess returns under Democratic presidents, indicating that investors have systematically under-priced Democratic policies that have benefited stocks. The instinctive preference of equity holders for Republican presidents is illustrated in Fig 2, which shows the tendency for stocks to surge upon Republican victories and decline upon Democratic victories. This is particularly the case for shock wins such as Truman’s in 1948 and Trump’s in 2016. However, such investors may be wise to reflect that the Dow Jones Industrial Average tripled under the Democratic presidencies of FDR and Bill Clinton, whilst the Republican presidents Hoover, Reagan and G.W. Bush presided over precipitous declines.”

 

Historical Political Futures Markets: An International Perspective

Every election season, investors are inundated with how the outcome will or will not effect markets. Like most predictions, they are often wrong. However, the idea of allocating your money based on your predicted outcome of an election is nothing new. This paper covers the long and storied history of political futures markets, with evidence of political futures markets dating back to the 16th century.

“This paper traces the operation of political futures markets back to 16th Century Italy, 18th Century Britain, and 19th Century United States. In the United States, election betting was a common part of political campaigns in the antebellum period, but became increasingly concentrated in the organized futures markets in New York City over the postbellum period.”

Even more astonishing, there have been people placing bets on the outcome of Papal succession in the Catholic Church since at least 1503.

“During the troubled papal conclave of 1549, the Venetian ambassador Matteo Dandolo observed that the Roman “merchants are very well informed about the state of the poll, and … the cardinals’ attendants in Conclave go partners with them in wagers, which thus causes many tens of thousands of crowns to change hands.” Odds were offered not only on which candidate among the papabile would win but also on when the conclave would end. About two months into this long and conflict-filled process, the market odds were 10 to 1 (implying a probability of approximately 9 percent) that this conclave would never elect a pope. Aversion to such activities eventually led Pope Gregory XIV, in March 1591 to ban on pain of excommunication all betting on the outcome of papal elections, the length of the papal reign, or the creation of cardinals.

Gregory XIV’s threat pushed wagering over papal succession underground, but at times it resurfaced. As a 1878 New York Times article noted: ‘The deaths and advents of the Popes has always given rise to an excessive amount of gambling in the lottery, and today the people of Italy are in a state of excitement that is indescribable. Figures are picked out which have some relation with the life or death of Pius IX. Every day large sums are paid for tickets in the lottery about to be drawn.’ Betting over the successor to Leo XIII in 1903 and to Benedict XV in 1922 attracted considerable press attention.”

In terms of political bets in the United States, the 1840 Presidential Election was a standout year:

“Election betting in 1840 was carried on as never before. The 1844 contest between Henry Clay and James Polk witnessed an even greater flurry of betting. Press reports indicate more than $6 million ($138 million in current dollars) changed hands in New York in the 1844 contest between Clay and Polk.”

Lastly, there were some just straight up weird bets:

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“In the United States during the 18th and 19th centuries non-financial bets were wildly popular, where the losers had to roll peanuts with a toothpick down a street, climb up a greased pole, shave their hair or make other public gestures. In 1900, there were at least a half a million such ‘freak bets’.”

Business in a Time of Spanish Influenza

As government initiatives like the Paycheck Protection Program and others wind down there are growing concerns over how domestic businesses will be able to fare without additional government stimulus. While there are countless differences between the two diseases, and they actually aren’t really comparable, there are similarities between how the nation responded to each with quarantining, social distancing, etc. This paper looks at the effect of Spanish Influenza on American businesses:

“Mandated shutdowns of nonessential businesses during the COVID-19 crisis brought into sharp relief the tradeoff between public health and a healthy economy. This paper documents the shortrun effects of shutdowns during the Spanish flu pandemic of 1918, which provides a useful counterpoint to choices made in 2020. The 1918 closures were shorter and less sweeping, in part because the US was at war and the Wilson administration was unwilling to let public safety jeopardize the war’s prosecution. The result was widespread sickness, which pushed some businesses to shutdown voluntarily; others operated shorthanded.

Using hand-coded, highfrequency data (mostly weekly) this study reports three principal results. First, retail sales declined during the three waves of the pandemic; manufacturing activity slowed, but by less than retail. Second, worker absenteeism due to either sickness or fear of contracting the flu reduced output in several key sectors and industries that were not ordered closed by as much as 10 to 20% in weeks of high excess mortality. Output declines were the result of labor-supply rather than demand shocks. And, third, mandated closures are not associated with increases in the number or aggregate dollar value of business failures, but the number and aggregate dollar value of business failures increased modestly in weeks of high excess mortality. The results highlight that the tradeoff between mandated closures and economic activity is not the only relevant tradeoff facing public health authorities. Economic activity also declines, sometimes sharply, during periods of unusually high influenza-related illness and excess mortality even absent mandated business closures.”

 

The Effect of the Central Bank Liquidity Support during Pandemics: Evidence from the 1918 Spanish Influenza Pandemic

Second Liberty Loan in Washington, DC

One of the most important aspects of the COVID-19 response for financial markets has been Fed liquidity. This paper dives into what that looked like 100 years ago in the Spanish Flu pandemic:

“The COVID-19 outbreak raises the question of how central bank liquidity support affects financial stability and promotes economic recovery. Using newly assembled data on cross-county flu mortality rates and state-charter bank balance sheets in New York State, we investigate the effects of the 1918 influenza pandemic on the banking system and the role of the Federal Reserve during the pandemic. We find that banks located in more severely affected areas experienced deposit withdrawals. Banks that were members of the Federal Reserve System were able to access central bank liquidity, enabling them and so to continue or even expand lending. Banks that were not System members, however, did not borrow on the interbank market but rather curtailed lending, suggesting that there was little-to-no pass-through of central bank liquidity.

Further, in the counties most affected by the 1918 pandemic, even banks with direct access to the discount window did not borrow enough to offset large deposit withdrawals and so liquidated assets, suggesting limits to the effectiveness of liquidity provision by the Federal Reserve. Finally, we show that the pandemic caused only a short-term disruption in the financial sector.”

 

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The post The Road Ahead appeared first on Investor Amnesia.

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Jamie Catherwood
My name is Jamie Catherwood, and I’m a Client Portfolio Associate at O’Shaughnessy Asset Management. Get your financial history fix through reading my articles, or those that I link to in my weekly “Financial History: Sunday Reads”.
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