A major investment risk: Congress at work

When Congress is in session, stock prices tend to stall or fall. When Congress is out of session, they tend to soar.

How much money did you lose last year? If you're like most Americans, your retirement funds, college savings accounts, and any other investments tied to stocks suffered greatly.

It didn't have to be this way. You could have followed a simple investment rule that would have spared you from much of the past year's losses.

You could have invested only when Congress is on vacation. It may sound a little crazy, but I am totally serious. When Congress works – and by "works" I mean "meddles" – it destroys wealth. When Congress doesn't work, wealth grows by itself.

From 1965 through 2008, looking at a total of 11,000 trading days, the annualized daily price gain of the S&P 500 Index is just 0.31 percent when Congress is in session. Out of session, that figure jumps to 16.15 percent, a daily difference of 50 times.

As government power and influence grow, the trend has intensified in recent years. From 2000 through 2008, in-session performance of the S&P is –12.4 percent. The out-of-session performance: +8.8 percent.

In other words, had you invested $10,000 only when Congress was in session from the beginning of 2000 through 2008, putting aside dividends, you'd have $4,615 today. Had you invested that same $10,000 only on days when Congress was on vacation, you'd have $13,416 today.

The reason for this is that the biggest risk in the market is the political risk that Congress will change the rules for many industries – and keep changing or threatening to change them.

Investors face enough risk as it is. They don't like added uncertainty. Political "reform" – or even just the prospect of it – adds a great deal of uncertainty and thus depresses stock prices. Doctors are told: "First, do no harm." Members of Congress seem to follow a different injunction: "First, do something. Worry about consequences later."

Imagine you are playing center field in a baseball game. In the middle of the second inning, the umpire announces that from now on, it takes five strikes for an out, and three balls for a walk.

The batters relax, and wait for a really good pitch to hit, with the result that there is 12-run rally in that inning by your opponents.

Finally, your side gets up to bat and your turn at the plate comes. The umpire turns to you and says, "You know, it's the second half of the second inning, so you'll be getting two strikes for an out, and seven balls before you are walked." You strike out. As does your team.

The score is 12–0 going into the third inning. The umpire goes into the dugout of the other side, huddles, emerges, and announces the game is being called on account of rain. The sky is completely blue.

You go to the commissioner of baseball to have the game canceled and replayed with the same rules for both sides. He tells you that the game is complete for purposes of the pennant race, but you can have a committee hold hearings after the World Series to determine what might have gone wrong.

This is pretty much what has been happening to investors with greater and greater intensity in recent years.

Once upon a time, we had a universal concept of bankruptcy. If AIG or Lehman Brothers or Washington Mutual or General Motors could not meet their obligations, they could go into bankruptcy, conservatorship, or receivership, where the bondholders could have a fair fight with the shareholders, employees, vendors, and others to determine who gets what according to well-settled rules. It was clear: three strikes, four balls, three outs, nine innings.

In the past year, in the name of saving us, the government has been administering leeches and boiling new herbal brews in a burst of activity. And to be fair, in some cases these changes didn't come directly from Congress.

Washington Mutual was forced into receivership without the shareholders having any chance to contest the action. And AIG was rescued with full payments made to creditors such as Goldman Sachs, which received $12 billion. In a fair fight in bankruptcy, Goldman might have gotten a partial payment of, say, $5 billion, saving taxpayers $7 billion.

In that game, Goldman scored the 12 runs. Lehman Brothers was denied the same resources made available to AIG, with the result that the credit markets seized up. As far as its competitors were concerned, that game was called on account of rain with the sky completely blue.

In recent months, consider how much uncertainty investors have had to confront:

•Massive financial interventions with simple-sounding acronyms but complex, changing features: TARP, TALF, PPIP, and others.

•The drama over how much Washington would bail out Detroit automakers, probably throwing good money after bad.

•A budget deficit that has gone from bad to unbelievable. Washington wants to spend its way out of this crisis, forcing the Federal Reserve to print unheard-of sums.

•New rules for homeowners facing foreclosure and bankruptcy. These rules could empower judges to rewrite mortgages and lower principal obligations. Such actions could have a far-reaching effect on banks, bondholders, and mortgage lenders.

•Threats that credit-card companies are about to have their rules drastically changed, as well – not to mention wholesale changes in healthcare, labor, and food industries. The changes on credit-card rules are intended to help consumers, but they may ultimately make credit less available and perhaps much more expensive, because they will limit consumer choice and put lenders at greater risk.

How much more change lies ahead? Would you invest in this climate?

My concern about the impact of political risk on the markets prompted me to open a mutual fund called the Congressional Effect Fund.

It is very simple. When Congress is in session, the fund invests in Treasuries and other cash equivalents. When Congress is on vacation, it invests in instruments that track the S&P 500 Index.

The fund opened last May 23, and for 2008 it was down –2.2 percent, as compared with –34.2 percent for the S&P 500 Index from the same date, a difference of 32 percentage points. So far this year it is down less than 1 percent, while taking on less risk.

I have two goals for this fund. The first and primary goal is to do well for my investors. The second is to help people understand the impact government in general and Congress in particular can have on their investments.

If the net result of launching the fund is simply that Congress takes another three weeks of vacation a year, a grateful nation will be much better off.

Eric Singer is the founder of the Congressional Effect Fund.

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