Stocks Handcuffed if Rove, Libby Indicted

As the stock market flops around like a wounded sockeye on the deck of a sinking ship, most of the blame is being focused on underwhelming economic growth, swelling inflation, energy price volatility, the Fed's relentless drive to crush home-buying speculation, the Refco bankruptcy, insider selling and plain old seasonality.

All of these are certainly playing a role, in varying degrees, in investors' extraordinary indecisiveness on whether to buy, hold or throw away stocks. But there may be one more hidden factor that is preying on investors' emotions, even if they don't recognize it yet. And that is the increasing possibility of a political crisis over the potential indictments of leading White House advisers I. Lewis Libby Jr. and Karl Rove.

I'm not saying that either of these aides will be indicted by special prosecutor Patrick Fitzgerald. Or that it will lead to a crisis of leadership. I'm just saying that the possibility of high-level indictments is only being hinted at in the recent market malaise, and that if it really happens, there could be a profound negative effect.

The Watergate Effect

While we tend to remember the 1973-74 market crash as coincident with a tripling of energy prices (due to the OPEC oil embargo), it also coincided with the drumbeat of congressional investigations, indictments and convictions over the Watergate break-in and cover-up.

The top of the market in that period was November 1972, just after President Nixon's re-election over George McGovern. The scandal began to unravel soon after that, with G. Gordon Liddy and James McCord, two Republican Party operatives, convicted of breaking into the Democrats' campaign headquarters in January 1973.

Over the next 18 months, the Nasdaq Composite fell 55% and the Dow Jones Industrial Average fell by about half. The decline -- which also coincided with a recession and the end of the Vietnam War -- drained money day after day from the stock market until the autumn of 1974. You may recall that Nixon, under threat of impeachment, resigned in August of that year. That lifted the market's mood a bit, but the final bottom didn't come for two more months, a short time after President Ford pardoned Nixon in September.

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Jon Markman, writer of TheStreet.com Value Investor, is the senior investment strategist and portfolio manager at Greenbook Investment Management, a division of Greenbook Financial Services. Separately, he is publisher of StockTactics Advisor, an independent weekly investment research service. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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