Amity Shlaes highlights in her latest Forbes magazine column a new tool for gauging the impact of politics on the economy. Shlaes contends the tool makes up for the fact that financial counselors are “cowards” who “don’t want to antagonize clients or governments by seeming political.”
All the more welcome, then, is a new index that does seek to capture the effect of events and politics. The Economic Policy Uncertainty Index, the creation of Scott R. Baker and Nicholas Bloom of Stanford and Steven J. Davis of the University of Chicago, attempts to assess the possibility that action by politicians may do damage, even when the politicians mean well. The EPU’s framers start by quantifying the use of the terms “uncertainty” and “uncertain” in the media, not when those terms appear in isolation but when they appear in relation to real-world terms such as “legislation,” “White House” or “Federal Reserve.” The EPU also tracks the expiry schedule of tax code measures. Its authors allow that the uncertainty generated by a temporary tax cut (a.k.a. stimulus) may outweigh any benefit to investors, a possibility beyond the comprehension of most lawmakers in either party. …
… The EPU goes back even to J.P. Morgan’s day, showing that a higher score on the news component did indeed correlate with the 1907 Panic. President Herbert Hoover loved action so much his nicknames were the “Great Engineer” and “Superman.” The EPU news measure duly spikes in 1932, the last year of Hoover’s presidency and a year in which the Dow Jones industrial average plummeted to the not-seen-since low of 41.
Franklin Roosevelt advocated “bold, persistent experimentation,” a license to act arbitrarily. The EPU suggests that the unexpected delay of the recovery in the late 1930s correlated with the uncertainty generated by Roosevelt’s laws and dominance. In the 1990s, when a more moderate Democrat, Bill Clinton, served as President with a Republican-dominated Congress, the index dropped and the stock market rose. Political moderates and political stalemate may be better for portfolios than rule by more extreme leaders. Investment advisors should bring themselves to tell clients that.
