A change in the political landscape is no cause for altering your portfolio.
By Christine Benz | 11-08-10 | 06:00 AM | Email Article

With the news of Tuesday's elections and the advent of a divided government, many media outlets began cranking out an array of articles prognosticating about the election's implications for the stock and bond markets.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

But should you try to position your portfolio to benefit from changes in Congress? I'd say no, for a couple of reasons.

For one thing, it's not at all clear how stocks are likely to behave with a Republican-controlled House and a Democratic-led Senate. True, conventional wisdom has long held that divided government is good for the markets. And following the election, some pundits hailed Republican control of the House as a business-friendly, pro-markets development, arguing that a divided Congress was more likely to keep a lid on tax increases and put the brakes on regulation.

But closer inspection of the data, as in this article, shows that stocks have actually performed worse when power is divided between Republicans and Democrats than when a single party is in control. And as Brett Arends notes in this article, the historical data about better market performance during periods of divided government are skewed by a handful of extreme periods, notably the very strong market performance during the Clinton and Reagan administrations. When you go further back into the history books, stock returns during periods of divided government paint a more mixed picture.

Attempting to gauge the broad market's performance in a post-midterm world is challenge enough. An even more difficult game is attempting to figure out which stocks and sectors stand to benefit from specific legislation coming out of Congress in the months and years ahead. That's because it's a good bet that partisan gridlock could be just as bad after the new Congress steps into office than it is now. (And if you care to weigh in on politics in general, you'll find many kindred spirits on our Politics & Investing Forum.) Debating the type of legislation that a divided Congress might push through may make for an interesting parlor game, but it's a mistake to incorporate those guesses into your portfolio until there's a new law on the books. As Yogi Berra (and later Lenny Kravitz) famously said, "It ain't over till it's over."

And when it is over and you see what appears to be a market-moving news item on the home page of your favorite news website, it's a good bet that it may already be reflected in current security prices. That's a key reason I'm not a believer in jockeying among asset classes, investment styles, or sectors in an effort to capitalize on broader macroeconomic trends. The spotty track record of professional investors executing tactical strategies, as my colleague Jeff Ptak discusses in this article, should also give you pause before implementing a more active strategy for your own portfolio.

But perhaps the biggest reason to think twice about making changes to your portfolio based on news like the election is that what's going on in Washington is but one of a huge assortment of factors that affect the economy, and in turn, stock and bond performance. Saying that a specific market outcome owes directly to Congressional action is a little like saying that you didn't catch a cold because you drink your orange juice every day. All that vitamin C may have helped, but it probably wasn't the sole factor in why you didn't get sick.

It's also worth noting that even when Washington acts in a fairly concerted fashion to effect a specific outcome--as was the case with recent efforts to revive the struggling economy--it won't necessarily be able to move the needle. That's because the private sector plays just as big a role--if not bigger--than the government in determining the direction of the economy and the markets. And as our economy becomes more and more global, the forces that shape it and the performance of our markets are even further out of the control of a single government.

It's fine to read the post-election prognostications and perhaps even make a few guesses of your own. But when it comes to reshaping your portfolio to benefit from the developments you expect to see in the future, think twice.  

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