- The Washington Times - Monday, January 26, 2009

Not that Barack Obama needed a wake-up call on Inauguration Day, but the stock market provided one anyway.

On the day Mr. Obama assumed the presidency, the Dow Jones Industrial Average delivered its worst Inauguration Day performance in its 113-year history, tumbling 332 points (more than 4 percent) and falling through the 8,000 level.

And that wasn’t the worst of the news.

Mr. Obama entered the White House inheriting a banking crisis that was again quickly reaching a boiling point, on a day that already-beaten bank stocks tumbled further, as Citigroup slumped 20 percent, JPMorgan Chase lost 21 percent and Bank of America plunged 29 percent.

What might the market have in store for Mr. Obama?

“It mostly depends on how effective he is in cleaning up the banks,” said Peter Morici, a business professor at the University of Maryland, who made his forecast for the first year. “If he can get private money back into the banks, the market will do well.”

Unless Mr. Obama restores confidence in the banks in the next several months, he will not have a salutary effect on the stock market or the economy, Mr. Morici said.

In order to promote sustainable growth in the stock market over the long term, Mr. Morici said, the new president must narrow the trade deficit by reducing the nation’s dependence on foreign oil and by restoring the U.S. manufacturing base.

“Manufacturing is being destroyed in America by Chinese mercantilists, who are manipulating China’s exchange rate to support exports and using protectionism to limit imports,” Mr. Morici said.

At least one conservative is bullish over the next four years.

“It may not be the ‘Mother of All Rallies,’” said David John, a senior research fellow at the conservative Heritage Foundation. “But there very likely will be a large uptick in the market across the board” over the next four years.

He noted that the stock market is a leading indicator. For example, the Dow, after languishing for years, began one of the greatest bull-market rallies in history in August 1982, several months before the U.S. economy’s deepest post-World War II recession reached its trough, when unemployment reached 10.8 percent. So, even if one assumes the economy will not begin its recovery until early 2010, the stock market could begin to rally this year, Mr. John said. Coupled with an economic expansion likely to last at least several years, if the past is any guide, the stock market could register a hefty net gain by the time Mr. Obama seeks re-election.

There are other reasons underlying stock-market optimism. Current stock prices reflect enticingly reasonable price-earnings ratios, meaning “there are a lot of bargains out there,” Mr. John said. There is also a tremendous amount of liquidity in the economy that has become temporarily tied up in government securities, where investors have fled in search of safety, and in excess reserves in the banking system, where banks are hoarding their cash to firm up their balance sheets.

“At some point, when confidence begins to return, the stock market is likely to boom,” Mr. John said. Investors will sell their government securities and use the proceeds to seek higher returns in the stock market. The reserves the banks are now holding in their vaults, so to speak, will eventually be available for loans, including to those who want to buy stocks, he said.

Bullish over the medium and long terms, Mr. John warned that there is significant downside risk in the short term as the economy continues to deteriorate.

He is not alone.

Nouriel Roubini, the New York University economist who predicted the bursting of the housing bubble and who correctly warned that the stock-market peaks achieved during the fall of 2007 represented “a sucker’s rally,” expects the Standard and Poor’s 500 to plummet further.

Mr. Roubini predicts the current downturn “will be the worst U.S. recession in the last 50 years and the worst synchronized global recession in decades.” He also expects weak growth recovery in 2010.

Forecasting a price-earnings ratio in the 10 to 12 range given a severe global recession, Mr. Roubini said, “The S&P; 500 could bottom - at some point in 2009 - at best at a level of 720, and in a worst-case scenario as low as 500 or 600. So, the worst is indeed still ahead of us.”

Ned Davis Research Inc., an independent research firm in Venice, Fla., disagrees with Mr. Roubini’s near-term forecast.

“Overall, we’re pretty positive in our outlook for the stock market,” said Ed Clissold, a senior global analyst. “We think the worst in the stock market is behind us.”

Because the stock market is forward-looking, he said, “a lot of the bad news from what could prove to be the worst recession since World War II has been priced into stocks. We are waiting for confirmation in the market.”

If reading tea leaves to discern future stock-market trends is fraught with risk, compiling the results of previous trends is straightforward.

President George W. Bush left office Tuesday after the major stock indexes turned in their worst performances during any post-World War II presidency.

To be sure, Mr. Bush assumed the presidency while the stock market was still deflating from a massive bubble that burst in early 2000. During his administration, however, the Dow and the S&P; 500 eventually recovered in full and even managed to hit all-time highs.

Nevertheless, as Mr. Bush returned to Crawford, Texas, the Dow lost 25 percent of its value compared with the day he became president. The S&P; 500 shed 40 percent of its value during the same eight years.

Ned Davis Research has culled stock-market and economic statistics dating back to 1901 and categorized the results according to which political party occupies the White House and controls Congress.

Stocks, measured by the Dow Jones Industrial Average, have nominally increased an average of 7.21 percent per year under Democratic presidents since William McKinley took the oath of office in March 1901 for his second term. When Republicans have occupied the White House during the previous 108 years, the Dow has increased an average of 3.02 percent per year.

In terms of purchasing power, what matters is the real (or inflation-adjusted) return from stocks. Inflation under Democratic presidents (4.60 percent per year) has been considerably higher than under Republican presidents (1.79 percent).

Thus, real stock returns have averaged about 2.5 percent annually during Democratic administrations. That’s still more than twice as high as the 1.2 percent average annual real return from stocks during Republican presidencies.

When Democrats control Congress, real stock returns have averaged 1.13 percent, which is less than half the real return (2.89 percent) earned when Republicans have ruled the legislative branch.

Stockholders have earned their highest annual real returns (5.63 percent) when Democrats occupy the Oval Office and Republicans control Congress. That return is roughly three times the returns stockholders have received when Democrats controlled both the executive and legislative branches (1.67 percent) and when Republicans ruled both branches (2 percent).

Shareholders have fared the worst (0.45 percent) when Republicans have held the presidency and Democrats have controlled Congress.

Bondholders, Ned Davis Research shows, do much better during Republican administrations, averaging a 7.75 percent annual return on government bonds. When Democrats are in the White House, bondholders earn a return of only 3.44 percent per year.

Democratic presidents have proved significantly more adept at maintaining a strong dollar than Republican presidents. Since 1901, against a trade-weighted package of foreign currencies, the dollar has appreciated an average of 0.36 percent per year during Democratic administrations. Under Republican presidents, the dollar has depreciated an average of more than 1.5 percent per year.


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