Trying to predict the U.S. presidential election with the stock market is a challenge.
There's no question that institutional investors try to decide weeks or even months in advance who is going to win, and how much the outcome will mean to their investments.
And there have been plenty of headlines this year on the market as seer.
"Stock Market Picks 90% of Presidential Elections," said a story in February about InvestTech researchers who used the Dow and a two-month time period to evaluate elections since 1900. (The accuracy percentage was actually 89%.) "Does the Stock Market Know If Obama Will Win?" asked a Daily Beast story in September based on a Standard & Poor's study of elections since 1948. The study used a three-month period before the election. Its accuracy was 88%.
"History Says a Roaring Stock Market Makes Obama Win Likely," said an August headline. Robert Prechter's Socionomics Institute in Gainesville, Ga., linked a three-year period of rising stock prices to landslide victories for incumbents. The study went back as far as 1824.
In fairness to Prechter, it's unlikely he would've written that headline. His research suggests "social mood" is the biggest factor behind markets and elections. He pointed out, "that a lot can happen in the stock market from August through October.
While such indicators are interesting, most of the studies are problematic. Many use the Dow Jones industrial average as the market gauge, but the Dow is no longer the best gauge for either the overall market or cutting-edge stocks.
The indicators also have no way of weighting the election vs. other factors driving stocks.
No Sure-Fire Prediction
Even 100% accuracy in an indicator doesn't prove a gauge is relevant. Coincidences happen. Oddball indicators sometimes are near perfect until they no longer work.
The chief problem is that the same market action can mean different things at different times.
Is a rising stock market in the months before the election a sign that an incumbent is good enough to keep (Clinton 1996), or is it a sigh of relief for a nation that is getting rid of a besieged president (Carter 1980)
Overall, the Nasdaq is up about 15% this year. Does that constitute a cheer for President Obama's second term, or a jeer on his way out
We can't pretend to know the answers. But we do find it curious that most of the election studies ignore .
Volume might be a clue on how the big money weighs the importance of an election. A small, quiet gain or loss in the indexes in the months leading up to the election could mean the big money doesn't see much at stake. A big gain or loss in strong volume could mean the opposite.
So where does the big money draw its gains, or risk losing its gains, today
Institutions certainly must weigh the economic chaos in Europe, the sluggishness in China and the Mideast mess as well as the U.S. election. Unfortunately, there's no way investors can assign specific weight to those factors.
This much is likely: The outcome of the 2012 presidential election probably already has been priced into the market to a large extent. Major investors aren't infallible, but they have more reason to study a situation closely than journalists and TV commentators do.
On Nov. 6, we will know what the market anticipated, but that's only the beginning of a new chapter.
The next chapter is what happens after the election.
Let's look at the past eight presidential elections through three lenses.
First, what did the market do in the six months before Election Day? Second, what did the market do in the roughly two months from Election Day to Inauguration Day? Third, what did it do in the six months after Election Day
The first lens — the six months running up to the election — could tell us if the big money thinks the election is important.
The second lens — after the election up to inauguration — is when some speculation sets in. Major investors must look at the new landscape, including any surprises in the House and Senate races, and decide what the president-elect can get done and if it's worth doing.
The third lens — the six months after the election outcome — includes a heavier dose of reality. The market learns with certainty which policies are being pushed and which were just promises to be instantly junked.
Elections 1980 To 2008
We used data from the S&P 500 in the elections from 1980 through 1992. The Nasdaq is used from 1996 to the present. As time went by, the Nasdaq became more of the leading index, in terms of broad representation and leading companies.
Let's look at the numbers, and the factors apart from the election, that can affect the market. In the majority of the eight cases, there was a change in market direction within a few months after the election.
• 1980: In the six months before the election, the S&P 500 rose almost straight up for a 21% gain 1. Volume was above average in 18 of the 26 weeks 2, suggesting the big money was active and optimistic. On Nov. 4, Ronald Reagan carried 44 states as he beat Jimmy Carter, the incumbent president. The Democrats kept control of the House, but the Republicans won the Senate.
Election to Jan. 20 inauguration: The S&P 500 rose 2% in a range-bound fashion. First six months after Election Day: the S&P 500 remained range-bound, easing to a 1.3% gain.
Bottom line: Slightly up in mostly sideways action after the election.
Other factors: Carter's deregulation changed the landscape for the trucking and the banking industries (both in 1980). Americans were held hostage in Iran through the campaign but freed on Inauguration Day.
• 1984: In the six months before the election, the S&P 500 gained 7%. Volume was below average in slightly more than half of the weeks, suggesting the big money was not fully engaged 3. Reagan carried 49 states as he defeated Walter Mondale. The Democrats kept control of the House, and the Republicans retained Senate control. Election to inauguration: The S&P 500 gained 3%. First six months after election: up 5.6%.
Bottom line: Moderate gain after the election.
Other factors: AT&T breakup (January 1984) changes the telecom landscape.
• 1988: In the six months before the election, the S&P 500 advanced 7%. Volume was up in a little more than half of the weeks, again showing nonchalance among institutions 4. George H.W. Bush carried 40 states as he defeated Michael Dukakis. The Democrats kept control of the House and Senate. Election to inauguration: The S&P 500 rose 4%. First six months after election: up 11%.
Bottom line: Good gain after the election.
Other factor: U.S. signs free trade pact with Canada (January 1988).
• 1992: In the six months before the election, the S&P 500 rose 0.7%. Volume was above average about half the time, again pointing to market indifference 5. Bill Clinton carried 32 states as he defeated incumbent Bush. The Democrats kept control of the House and Senate. Election to inauguration: The S&P 500 gained 3%. First six months after the election: up 5.4%.
Bottom line: Moderate gain after the election.
Other factor: Britain was forced to withdraw the pound sterling on Black Wednesday (Sept. 16, 1992) during a monetary crisis.
• 1996: In the six months before the election, the Nasdaq rose 3.6%. Volume was above average slightly more than half the time, pointing to a lack of enthusiasm 6. Bill Clinton carried 31 states as he turned back Bob Dole. The Republicans kept control of the House and Senate. Election to inauguration: The Nasdaq advanced 11%. First six months after election: up 9%.
Bottom line: Good gain after the election.
Other factor: New telecommunications law (February 1996) aimed to deregulate broadcasting market, but critics said it favored established broadcasters.
• 2000: In the six months before the election, the Nasdaq fell 7%. Volume was above average in 15 of the 26 weeks 7. George W. Bush carried 30 states as he defeated Al Gore. The Republicans kept control of the House. The Republicans kept control of the Senate only through the potential tie-breaking votes of Vice President Dick Cheney. From election to inauguration: The Nasdaq lopped off 19%. First six months after election: down 36%.
Bottom line: Big loss after election.
Other factor: Court declares Microsoft a monopoly (April 3, 2000), adding fuel to the dot-com meltdown.
• 2004: In the six months before the election, the Nasdaq rose 2%. Volume was above average in slightly more than half the weeks 8. George Bush carried 31 states, defeating John Kerry. The Republicans kept control of the House and Senate. From election to inauguration: The Nasdaq gained 3%. First six months after election: down 3%.
Bottom line: Small loss after the election.
Other factors: U.S. at war in Iraq and Afghanistan.
• 2008: In the six months before the election, the Nasdaq skidded 28%. Volume was above average in 18 of the 26 weeks, suggesting the big money was actively pessimistic 9. Barack Obama carried 28 states as he defeated John McCain. The Democrats kept control of the House and took over the Senate. From election to inauguration: The Nasdaq slid 19%. First six months after election: down 1%.
Bottom line: Initial loss after the election is trimmed to small loss.
Other factors: Financial crisis took down Bear Stearns (March 2008) and Lehman Bros. (September 2008).
• 2012: In almost six months before the election, the Nasdaq is up about 1%. Volume looks like it will finish above average in slightly more than half of the weeks.
Other factors: U.S. fiscal cliff, European debt crisis, Iran nuclear threat and China slowdown.
Overall, five of the eight elections showed gains in the first six months after the election. Although data are incomplete for 2012, only two elections appeared to attract heavy buying or selling: Reagan-Carter in 1980 and Obama-McCain in 2008.