The bear and the donkey

tauringhuang.

Aug 10th 2008
From Economist.com

What the market says about the election


CAN the markets predict the Presidential election? Many people believe in the acumen of those who participate in the Iowa Electronic Markets. Their “winner takes all” contract strongly favours Barack Obama at the moment, with a price of just over 62 (the winner gets 100, the loser gets zero). That probably reflects the opinion surveys: in CN*’s poll of polls the Illinois senator currently has a five-percentage point lead.

But maybe investors can get just as a good a guide from the stockmarket. Sam Stovall, the chief investment strategist of Standard & Poor’s, has investigated the performance of the markets in the three months (August through October) leading up to the presidential vote.

There have been 20 elections since 1928. The stock market has risen in that three-month period 14 times. Out of those 14 examples, the candidate of the governing party was re-elected 11 times. Of the six occasions when the stockmarket fell, the candidate of the opposition party won five times. In other words, this indicator has an 80% average success rate.

The market indicator is on a roll, having got every election right since 1984. The last false signal came in 1980, when a 4.8% gain failed to translate into a second term for Jimmy Carter. Interestingly, the tiny fall in the market in 2000 translated into the tiny margin (in the electoral college) of George W Bush.

On that basis, if the market rallies between now and the end of October, Senator McCain will be elected; if it falls further, Senator Obama will occupy the White House. Given that the market is already down heavily this year, that ought to be good news for Senator McCain, who might benefit from a relief rally.

Why might this indicator work? The obvious explanation would be that a rising stockmarket reflects a buoyant economy, and that in turn makes votes feel good about the governing party. Of course, the economy has not really been that strong this year—one reason why the Democrats may be ahead in the polls.

The latest piece of bad news was a 455,000 rise in jobless claims in the week ending August 2nd. The key figure may be a 6% unemployment rate; on four out of the last five occasions, the governing party has lost the election when the jobless level has been above 6%.

The alternative could be that the causality goes the other way round; the trend in the opinion polls determines the market mood. Republicans and Democrats have split the last 20 elections down the middle. In the months preceding victories for the Republican party, the market rose seven out of 10 times; exactly the same is true of the Democrats. So it doesn’t look as if the polls are the driving factor. (Incidentally, although Wall Street traditionally favours Republicans, returns in Democrat years have averaged 10.7% against 7.6% for the Grand Old Party.)

Whatever the reasoning, the duty of political partisans is clear. All you Republicans, get out your wallets and start buying stocks. And all you Democrats, join a hedge fund and learn how to short the market.