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How presidential politics play with fall market jitters

Given the markets' performance during the past century, the weeks and months preceding the Nov. 7 election may be a prime time to invest.

With elections approaching and presidential candidates nearing a dead heat, gamblers may want to wager in a slightly safer venue: the stock market.

Autumn is a relatively unpredictable and volatile season on Wall Street, playing host to the crashes of 1929 and 1987. The Dow Jones industrial average has been down an average of 0.8 percent every September for more than 80 years.

But presidential election years are typically an exception to the frenetic fall rule. More often than not, elections are economic juggernauts that lift markets.

Given the markets' performance during the past century, the weeks and months preceding Nov. 7 may be a prime time to invest.

Since 1972, the prospect of a new commander in chief has lifted the Nasdaq an average of 0.4 percent in October and 2.8 percent in November, according to the 2001 Stock Trader's Almanac. By contrast, the Nasdaq in non-presidential election years has averaged a 0.6 percent drop in October and a 1.8 percent gain in November.

The Dow Jones industrial average has finished the year up in 29 of the past 42 election years, according to the Almanac. (Prior to 1886, the performance of other indexes was tracked.)

"What we're looking at here is a very strong remainder of the year and strong early next year based on historical patterns," said Jeff Hirsch, vice president of the Hirsch Organization, which publishes the Stock Trader's Almanac. "I'm looking for another little blip down on the averages and then come mid- to late October, we'll probably be ready to launch into new highs on everything."

Why do the markets perform better during the fall in election years?

It seems to have little to do with the candidates' economic policies or their stances on issues facing the market-moving technology sector. Rather, experts say, elections boost markets because both candidates stoke consumer optimism and tout the healthiest aspects of the economy.

"The presidents do a really great job of propelling the market right about the time they are being elected because they know the economy is directly linked to their personal success," said Barry Libert, a partner with Arthur Andersen and co-director of the Massachusetts Institute of Technology's New Economy Research Lab.

"It's in both of their interest to sustain the expansion, as well as extend the expansion, after they're elected," Libert said of the front-runners, Texas Gov. George W. Bush and Vice President Al Gore.

Sunny forecast
Regardless of why the candidates push up the markets, experts agree that investors this year will be able to count on a boost, however modest.

Joseph Keating, chief investment officer of the Kent Funds in Grand Rapids, Mich., predicts that the Standard & Poor's 500 index should be up 12 percent to 15 percent by this time next year. He refers not only to historical data during presidential years, but also to economic indicators that suggest the market has slowed.

"I think the downside risk is rather limited given the correction and the speculative end of the market that occurred earlier in the year, i.e., the bursting of the Internet bubble," Keating said. "History tells us if we move to a lower-growth environment that allows us to have lower interest rates, that common stock performs much better in that environment than in an environment with higher growth and interest rates."

Another reason investors should be optimistic: This fall might not have quite as many vicissitudes as previous autumns, thanks to the unlikelihood of short-term interest rate hikes.

A slowing economy seems to have persuaded the Fed to ease off interest rate hikes, maintaining rates throughout the summer. As more economic news confirms the cooling of the economy, economists have become relatively confident that higher interest rates will not disrupt markets in the near future.

"Fears of interest rate hikes abated during the month of August," said Tracy Eichler, an investment strategist at PaineWebber, which runs the index of investor optimism that measures investor sentiment on a monthly basis. Eichler said 53 percent of 1,000 investors surveyed did not expect a rate hike in the next few months.

"Because it's an election year and the Fed prefers to be on hold, interest rates are less of a concern right now," she said. "Two things primarily move the markets--interest rates and earnings--and with the current behind us, investors can focus on upcoming (third-quarter) earnings."

Earnings warning
The only factor that may threaten markets, analysts said, is the upcoming earnings season. Companies that will miss earnings expectations for the third quarter typically warn investors in mid- to late September, a few weeks before the quarter ends. Warnings often cause markets to stumble.

A few major disappointments from some major technology companies could deflate investor enthusiasm, said Dick McCabe, chief market analyst at Merrill Lynch.

"The other side of a slowing economy is the effect on corporate profits," McCabe said. "With tech stocks trading at 100 times earnings, one little slippage could have a dramatic effect."

Although most economic and historic data suggest that the markets are in for an uptick this fall, many experts caution investors not to become overly exuberant.

According to a PaineWebber survey of investors under 40 years old, most expect returns of 18 percent during the next 12 months. But analysts see more modest returns.

"We're looking to go back to historical returns, not unprecedented returns," Eichler said.

One reason gains may be relatively modest: Consolidation among e-commerce companies and other technology players means that the number of high-priced stocks will shrink.

Special report: End of the Beginning "There's a decreasing number of stocks that we want to own, so it's hard to make gains in the overall market," said Jeff Rubin, director of research at Birinyi Associates.

Merrill's McCabe recommends looking for stocks in "sectors that do not have the glamorization and overplay that the tech sector received" during the tech-driven bull market of the past year. McCabe recommends stocks in aerospace, home building, airlines and health care.

He believes technology stocks remain relatively high risk, despite the promise of an election year boost. The sector has enjoyed a run that some say happens once in a generation--and many economists say tech stocks have more room to slide.

"In periods of exuberance, it takes more than one corrective phase to complete the corrective process," said McCabe, who would not speculate when another tech correction might arrive.

Better than reading tea leaves?
If betting on tech stocks in a presidential year seems too risky, observers might put fanciful bets on the election itself. While presidential elections can provide a rough guide to predicting the markets, the markets may also help predict the next president.

According to the Stock Trader's Almanac, if the Dow Jones is higher the day before the election than it was the day after the last convention day, this signals that the incumbent is likely to win. Of the 16 presidential elections since 1900 in which the incumbent parties were victorious, 14 were foretold by rising stock prices.

Investors can also prepare for after the election.

The Almanac shows the market has an obvious preference for Republican presidents. Since 1900, 10 of the 13 times a Republican president has won, the market has risen the next day an average of 0.9 percent. By contrast, the market rose on only four of the 12 occasions that a Democrat won--down an average of 0.54 percent.