Lame-duck Congress may hurt stocks

At least one fund manager is staying out of the market for the rest of 2010 to avoid political risks.

By TheStreet Staff Nov 3, 2010 8:45AM

Washington, D.C. © Bilderbuch/Design Pics/CorbisBy Robert Holmes, TheStreet

 

Investors say political gridlock stemming from an energized Republican Party will bode well for the stock market.

 

Eric Singer, the manager of the Congressional Effect Fund (CEFFX), isn't among them.

 

With the GOP capturing the House, the two-month lame-duck session will be "incredibly dangerous" for investors, the mutual fund manager says.

 

"As we've had more political volatility, it has translated to less and less certainty as to how a particular piece of legislation could play out," Singer says. "The public is extremely skeptical."

While Democrat incumbents Barney Frank and Harry Reid managed to hold on to their seats in the House and Senate, respectively, several Republicans, including Arkansas' John Boozman and Wisconsin's Ron Johnson, were able to wrest control from lame-duck Democrats. Newly elected leaders begin the next session Jan. 3, leaving current members less than two months to tackle key unresolved issues.

 

The 111th U.S. Congress and its Democratic majority made wide-reaching policy decisions, including an overhaul of the U.S. health care system and reform of the financial industry.


However, neither the House nor the Senate has yet to pass a budget. It is also uncertain whether those departing Capitol Hill will move to stop the expiration of the Bush tax cuts or if Congress will take up cap-and-trade legislation, both of which are hotly contested.

 

The previous lame-duck session occurred in 2004 after Republicans increased their majority in both chambers, and that was a boon for investors. From that year's election on Nov. 2 through the end of 2004, the Dow Jones Industrial Average ($INDU) rose 8% and the S&P 500 ($INX) gained 7%. Singer doesn't expect the same result this time around.

 

"It may turn out that the lame-duck session is a whimper, but I doubt it," he says. "There is a very interesting chance that after an extraordinary election, the guys who are still in office won't just go away. If I were an investor, I'd be very concerned about my political risk during the lame-duck session. There is a relentless amount of uncertainty that is created by the presence of legislation."

 

As manager of the Congressional Effect Fund, Singer seeks to capture the historically higher returns on out-of-session days and avoid political risks when the House and Senate are in session. It is the first mutual fund that explicitly attempts to minimize exposure to the potentially negative effect of Congressional legislation.

 

With a lame-duck session set to begin, Singer says the fund will be in cash, in Treasurys or neutral (for dividends) when Congress is back in session. When Congress is out of session, the fund goes long the broader U.S. market through

S&P 500 ($INX) exchange-traded funds.

 

The Congressional Effect Fund is small ($8 million in assets) and has a fast turnover rate because of the nature of the investment theme. Currently, it has a net asset value of $10.70 and a minuscule beta compared with the broad market, which is simply a reflection of Singer's staying out of the stock market.

 

"We've had a very active Congress over the past few years, so they've been in session almost three-quarters of the time," Singer says. "Our performance hasn't suffered, because we've been able to capture a lot of the upside in the market."

 

The mutual fund, which is up 15% in 2010 and ranks among the top 1% in performance and bottom 1% among risk, benefits from so-called relief rallies and uncertainly over legislation. Still, the fund trails the S&P 500 over three months by a wide margin.

 

"Whenever Congress is even considering legislation, the stocks of those industries come under pressure. Those sectors are often big enough to affect the entire market," he says. "Talk is not cheap. When they simply talk of reining in the insurers, we all lose wealth."

 

While some have called the Congressional Effect Fund a novelty, much like the Vice Fund (VICEX), Singer says his returns validate the investing style.

 

As with everything in the investing world, the Congressional Effect Fund is no sure bet. When Congress enacted tax cuts in 1997, including a cut to the capital-gains tax, the annualized average price increase on the days when Congress was in session was 59.5%, according to data collected by the Congressional Effect Fund. When Congress was out of session that year, there was an annualized average price loss of 4.6%.

 

Some analysts are arguing that gridlock in Congress would provide equities with some room to run higher. But Singer isn't expecting the same results in the new year.

 

"In the past, there is a lot of statistical evidence that says gridlock is good," he says. "I question whether gridlock is going to be as good at a time when there is more of a sense of urgency brought on by the financial crisis."

 

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