October Surprise for the Investor Class

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How will investors affect the midterm congressional elections on November 7? (That was the cogent question asked of me by Lawrence Kudlow when I appeared on yesterday afternoon's edition of CNBC's Kudlow & Company.) To even begin to tackle the issue beyond a sound bite, you first have to understand what the "investor class" is. Slightly more than half of all U.S. households own stock, either directly or through retirement accounts such as 401(k)'s and IRAs, according to the Investment Company Institute. In the early 1990s, that fraction was only about a third. And in the early 1980s, just a fifth of all households invested in stocks. During the 2004 presidential election, about 46 percent of investors, according to polling by Zogby International, identified themselves as members of the investor class. And this group voted for President Bush in a landslide over Sen. John Kerry, 61 percent to 39 percent.

Now, it's tempting to dismiss these results as being statistically meaningless. Perhaps investor class is just another way of describing mid-to-upper-income white men, a group that typically votes for the GOP. But investors are a far more diverse group than that. Some 91 million Americans owned mutual funds in 2005, according to the ICI. And in about a quarter of fund-owning households, it's the women making the investment decisions. What's really fascinating is that the stock market didn't do particularly well in the months leading up to the 2004 election. Investors opening up their third-quarter financial statements found that the S&P 500 was flat for those three months and was down for the year. Only in the final few days before the election did the market show any life at all, gaining about 2 percent. Yet the investor class flocked to Bush.

So how about in 2006? Well, a Zogby poll taken in early June—just as the market started to rally—showed Bush with a 41 percent approval rating among investors. That's not so hot, but it was better than his 36 percent approval rating among voters overall. Since then the market has taken off. Investors opening up their financial statements this month will see a nice "October Surprise" in them. The S&P 500 gained nearly 5 percent in the third quarter and is up more than 11 percent since early June. Plus the Dow Jones industrial average, the market barometer that most people pay the most attention to, has been rattling off record highs as it approaches the 12,000 mark. All this seemed to be helping Bush and the congressional GOP—ratings for both were moving higher—until the Mark Foley sex scandal broke. Polls since that news hit have been devastating for Republicans and joyous for Democrats. The House GOP contract at the popular TradeSports betting market has cratered. It looks like Yahoo! stock right now. Right now, at least, it seems as though voters are thinking more about scandal headlines than financial statements.

One more thing: Democrats will correctly point out that stocks have historically done better when their party has controlled the White House than when the GOP has. So why do investors continually favor Republicans? A recent study of investor voting behavior out of the business schools at Stanford University and the University of Pennsylvania offers this possible explanation: While past Democratic presidents may have pursued market-friendly policies, investors stubbornly expect future ones not to. And one reason for that may be that the GOP tends to aggressively support more favorable treatment of capital gains and dividend income. By contrast, Kerry vice presidential candidate John Edwards—a possible 2008 White House contender—has advocated raising capital-gains rates for wealthier investors.