The Congressional Effect: How Congress Impacts the Stock Market

The U.S. Congress is currently in recess, and this is good news for stock investors. According to a study conducted by Michael Ferguson and Douglas Witte, professors of finance and economics, the stock market has historically produced the majority of its gains when Congress is out of session. In fact, over 90% of the capital gains of the Dow Jones Industrial Average have occurred on days when Congress is not conducting business.

The study, titled “Congress and the Stock Market,” highlights the Congressional Effect, which is the phenomenon of higher returns in the stock market during congressional recesses. While this effect is evident across the market, it is particularly pronounced for smaller-cap stocks. The authors found that the annualized return of the CRSP Equal Weight Index, which gives equal weight to all publicly traded stocks, showed the largest difference between in-session and out-of-session returns. The other three indices, which are dominated by large-cap stocks, also exhibited a statistically significant Congressional Effect, albeit about half as significant as the equal-weight index.

Although the research only covers data up until 2004, Ferguson believes that the Congressional Effect likely persists to this day. He mentioned that there is no reason why the pattern would have disappeared since then. Determining which days Congress is not conducting business requires significant effort, which is why the authors have not updated their research. They treated pro-forma sessions as Congress being in recess, as these sessions often do not involve any business.

One interesting finding from the study is the correlation between the magnitude of the Congressional Effect and Congress’ public approval rating. Currently, Congress’ approval rating is around 12%, close to all-time lows. This suggests that if Congress is perceived to create more harm than good, there will be greater uncertainty on Wall Street when they are in session. This uncertainty leads to increased volatility in the stock market, as investors demand a higher expected return to compensate for the added risk.

The professors quote Will Rogers’ famous saying that reflects the sentiment towards Congress: “This country has come to feel the same when Congress is in session as we do when a baby gets hold of the hammer. It’s just a question of how much damage he can do with it before we take it away from him.”

In conclusion, the research conducted by Ferguson and Witte suggests that stock investors should be optimistic during congressional recesses. The historical data indicates that the stock market tends to perform better when Congress is not conducting business. The correlation between the Congressional Effect and Congress’ public approval rating further supports this finding. While the study’s data only goes up until 2004, there is reason to believe that the pattern still holds true today.