Dynamics of the political business cycle

Submitted By Alex Forshaw

In recent years, much more attention has been paid to the “political business cycle,” and how it can affect returns.

The theory behind the political business cycle is that the government, itself the largest player in any nation’s economy, tends to “prime the pump” in the run-up to elections, so as to remind the voters how great the powers-that-be are for the economy, and improve the ruling party’s chances at winning elections. In many countries, this has evolved to the point that one ruling party has a virtual lock on the government. Japan, for example, has had the same ruling party since 1950, with two brief exceptions.

Having a good grasp of when that pump-priming occurs – and, much more importantly, what sectors can be expected to gain favorable treatment from governments – can potentially yield very high returns.

In the United States, for instance, the structure of Congress gives lower-populated states, i.e., farm states and Alaska, disproportionate sway over budget allocations. This leads to such “stable disequilibria” as California getting only about 75% of federal spending, relative to the amount of tax revenue it provides. New York gets similarly poor returns. Alaska and New Mexico, by contrast, get an annual return of over 100% from their (lack of) investment in the federal gravy train.


Economies of “red states” have done very well over the past decade. Conservatives wasted no time in bragging that the market’s verdict was in on the merits of conservative, market-based governing principles. Democrats scoffed that, far from rewarding free enterprise, superior red-state performance merely reflected Republican states apportioning a disproportionate amount of largesse for themselves (a charge which holds a lot of merit).


Particularly as the balance of Congressional power returns to states with majority-Democratic congressional delegations, it should be expected that those blue-state assets (particularly real estate) enjoy renewed appreciation. Expect real estate in the districts of congressional committee chairmen to perform spectacularly.

As far as equities are concerned, the insurance industry and pharmaceuticals can be reasonably expected to depreciate considerably, as demand for universal healthcare [sic] gains momentum along with the rising fortunes of the Democratic Party in general. Expect defense stocks to continue to do well, but slightly less so under a 2008 Democratic administration. Farm stocks (Archer Daniels Midland), of course, will do staggeringly well regardless.



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