When U.S. politics sours, investors stall
The Partisan Conflict Index, which analyzes news articles, has zoomed to new heights. More rancor coincides with a drop in U.S. firm investments, a former Federal Reserve economist finds.
When Republicans and Democrats can't agree what to do, investors tend to stall, too.
So watch out: This spring, we've had the worst partisan fighting in Washington since at least the 1970s, concludes economist Marina Azzimonti's "Partisan Conflict Index," which the Federal Reserve Bank of Philadelphia began posting in 2014.
The index analyzes news articles (not commentaries) from national and big regional newspapers for terms detailing the level of political conflict.
Tracing past periods, the index has tended to rise with heated rhetoric before presidential elections.
It falls in times of war, when parties temporarily bury their differences. The index spiked at the beginning of the Gulf War debate, and fell during the war, and again during the 2008 financial crisis.
The index zoomed higher after Republicans took back Congress partway through the Obama administration. And it hit an all-time high, at 270 percent of its 1990 benchmark, in March during the clamor over the health-care debate, the calls for Russia investigations, and Trump's cabinet appointments.
That score was the highest "partisan conflict" the index has measured for any month in the 37 years for which Azzimonti ran the numbers.
Up and down -- The index doesn't mean much by itself. Azzimonti and other scholars have been checking the index against actual investments and finding what they say look like clear relationships: When it's calm in Washington, investors seem to gain confidence and buy more, stimulating the economy.
When party leaders bicker and insult, U.S. and at least some foreign investors appear to delay pumping money into business -- their own and other people's.
For example: Azzimonti says she's found high Political Conflict Index periods coincide with a drop in U.S. firm investments counted in the extensive Compustat financial database, "especially for those that depend heavily on government spending, and those who make large political contributions" through political action committees.
She'll be presenting a paper on this apparent confirmation of what you might expect for war contractors and politically connected industries at the semiannual Carnegie-Rochester research conference this week. She told me she's bracing for "the verdict" by her peers.
In a paper published by the National Bureau of Economic Research, Azzimonti says she's also found "a negative relationship" between high Political Conflict Index (PCI) scores and foreign direct investment in U.S. businesses.
A former Federal Reserve economist and now an associate professor at Stony Brook University, she's working with the Philly Fed on another index that will focus particularly on trade-war conflict reports so they can be compared with trade levels: "I just got the data."
The Partisan Conflict Index
Other scholars claim parallel results:
A U.S.-British group of economists led by William Bryce Hankins III of the University of Alabama, in a "working paper" posted by the Bank of England, says that periods of high Political Conflict Index scores coincide with significant increase in cash holdings -- as opposed to longer-term assets -- at U.S. firms.
The damping effect of poisonous U.S. politics even seems to cross the Atlantic, given Europe's reliance on U.S. and foreign markets: A paper published in Elsevier's Economics Letters by Chak Hung Cheng of South Carolina State, and a group including Hankins has found that a high PCI shows "a negative and significant effect on European industrial production."
Azzimonti is careful to note that high conflict scores don't signal whether the stock market will rise or fall: "There are many other factors at play."
Political conflict could be good for some stocks if it blocks policies that investors find threatening, she added.
It's useful to be able to show political conflict is associated with weaker investment. But that doesn't mean headline counts have predictive value that is easy for market-watchers to exploit.
Hope of tax cuts, fear of congressional gridlock, fast-changing Trump priorities: Which issue will dominate investors' cash allocations?
"Showing causation is a really difficult issue," Azzimonti warned.