After months of equity-market agony, last week provided a bit of respite. For the week as a whole, the Standard & Poor's 500 Index advanced almost 11 percent.
Why did markets finally turn around, at least for a while? There were two big positive forces.
The first was a sign that the efforts of the U.S. Treasury Department and the Federal Reserve may finally be paying off. Bank of America Corp. and Citigroup Inc. both announced that they expect to be profitable this year, something that seemed almost unthinkable a few weeks ago. The light might finally be visible at the end of the tunnel in the U.S. financial crisis.
The second thing might well have been just as important. The Democrats took a week off.
Since his inauguration, President Barack Obama and his Democratic colleagues have worked at a feverish pace, announcing countless new policies. In January they provided a general outline of all of their plans and pushed through a number of policy changes that were friendly to organized labor and unfriendly to companies.
Early February brought the promise and then the furor over Treasury Secretary Timothy Geithner's vacuous plan, the stimulus debate, and the Obama budget, which was stuffed with big spending, big deficits and tax hikes.
Last week, aside from the signing ceremony for a spending bill that already passed the House of Representatives in late February, nothing happened. Washington was quiet, and the world's financial markets rejoiced. Was it just a coincidence?
There is a strong theoretical reason to believe it wasn't.
News and Markets
When markets function well, today's prices reflect the balance of the odds that tomorrow will provide good news or bad news. Markets move because news is better or worse than expected. Against this backdrop, it's easy to explain the depressing correlation between Obama's policy announcements and market calamity. Prior to the release of his budget, markets were not sure whether Obama would govern like a moderate or a liberal. The War Against Business evident in his plans was the kind of news that can move markets.
The good news about Citigroup and Bank of America could easily have been outweighed by bad news for companies out of Washington. If, for example, the Democrats had successfully pushed through their so-called card-check legislation--making it easier for unions to organize America's workplace without secret ballots--then the financial markets could well have gone in a different direction. Quiet was surely preferable to that.
What Moves Stocks
There is interesting empirical precedence as well for the equity market celebrating silence. It comes from an unlikely place: a famous academic study of what moves markets, co- authored by Lawrence Summers, now director of Obama's National Economic Council.
Back in 1989, Summers and his co-authors, James Poterba of Massachusetts Institute of Technology and David Cutler of Harvard University, published a paper in the Journal of Portfolio Management with the provocative title, "What Moves Stock Prices?" They gathered data on equity-market returns between 1926 and 1985 and identified the 50 biggest stock market movements. Then they set out to discover what caused the big movements, relying on accounts in The New York Times.
Their data suggest that some big movements, especially declines, were clearly associated with events. For example, the market dropped 6.62 percent on Sept. 26, 1955, when President Dwight Eisenhower suffered a heart attack, and 5.4 percent on June 26, 1950, at the outbreak of the Korean War. The market dropped 4.61 percent when Harry Truman defeated Thomas Dewey.
But for most of the big movement days, the news seemed relatively light, even nonexistent. The authors wrote: "On most of the sizable returns days, however, the information that the press cites as the cause of the market move is not particularly important."
That is especially true for the days when the market advanced. The newspapers often failed to find any explanation at all for good days. When stocks surged 5.02 percent on May 27, 1970, the Times wrote that it happened "for no fundamental reason." On June 29, 1962, according to the Times, "stock prices advanced strongly chiefly because they had gone down so long and so far that a rally was due."
Silence may be golden because policy makers on average mess things up. There is even a mutual fund that is set up to profit from this observation. According to the Web site for the Congressional Effect Fund, between 1965 and 2008 the S&P 500 Index increased at an annual rate of about 16 percent during periods when Congress was out of session, and increased only 0.31 percent when Congress was in session.
Benefiting From Inaction
From January 2000, this contrast is even more striking. The S&P 500 gained more than 8 percent on days when Congress was out of session and declined by more than 12 percent on the days when Congress was in session. Even this year, if you only put your money in the market on days when Congress was out of session, you would have suffered losses of 4 percent, outperforming the S&P 500 by roughly 12 percent.
The political vacation was informal this week. If President Obama really wants things to get better, he should take the rest of the year off.
Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI.