One sector really loves gridlock: Financials

November 2, 2010: 10:44 AM ET

By Joshua Steiner and Allison Kaptur, Hedgeye

With the election underway, we thought it would be helpful to look back at how financial stocks have performed relative to other sectors in times of both divided government and a gain in Republican power. The following charts tell the tale.

The first chart shows broad sector performance from 1972 to present during times of divided and unified government. We define divided government as any 2-year congressional term during which the party of the presidency differed from either the party in control of either the House or Senate.

We used the S&P Spiders to denote sectors. For those unfamiliar, XLF = Financials, XLY = Consumer Discretionary, XLE = Energy, XLV = Healthcare, XLI = Industrials, XLP = Consumer Staples, XLB = Basic Materials, XLK = Technology, XLU = Utilities.

Interestingly, Financials showed demonstrably better performance under divided government than under unified government, posting an average 20% return over a two-year period (9.5% annualized) as compared with 9% (4.3% annualized) when the government is unified. This is quite different from the broader market, where the S&P 500 outperforms during a unified government. This is interesting, as conventional wisdom is that gridlock is good for the market. While this appears true for Financials, it appears to be false for the market at large.

The next chart looks at the four major subgroups within Financials including Banks, Insurance, Specialty Finance and Brokers/Asset Managers. The blue columns represent performance by subsector during periods of divided government. Historically, banks have been the weakest on a relative basis and Brokers/Asset Managers the strongest.

The following chart looks at how sectors perform when Republicans gain power, when Democrats gain power and when there is no change. Again we're looking at total performance over a two-year Congressional term. Financials have historically been the best-performing sector when Republicans gain power, and, for reference, the worst-performing sector when Democrats gain power.

Finally, we look at subsectors within Financials on the same basis as the above analysis. When Republicans gain power, as they're most likely to do today, Brokers/Asset Managers and Specialty Finance companies have historically been the best performers.

A note on our methodology. We analyzed performance of each subsector using its SPDR. For the time period before the SPDR existed (prior to 1998) we used the price performance of the ETF's current holdings over the relevant period. Each series is indexed to 100 when the ETF first traded in 1998 to enhance comparability. All our price data comes from Factset.

For reference, we're neither asserting, nor do we subscribe to the view that election outcomes and/or which party is in power affects price performance. The scope of that question is well beyond what we've tried to do here. We are also working with a small number of data points, given the 2-year duration of the election cycle, which decreases the statistical significance of these results.

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Hedgeye

Hedgeye, a real-time investment research firm founded in 2008 by former Carlyle-Blue Wave portfolio manager Keith McCullough, operates as a virtual hedge fund. Staffed by research analysts from across Wall Street, Hedgeye offers fundamental, macro and sector analysis, present picks in a transparent way to its clients. It has built a stable of subscribers, which includes hedge funds and mutual funds, and recently launched a retail investor product.

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