After the US Supreme Court inexplicably redefined Obamacare to uphold its constitutionality, politics are very much back in the news.  And with the all-important US elections only 4 months away, it’s only going to get worse.  Interestingly, the state of the US stock markets heading into voting is likely to both predict and heavily influence the outcome.  The markets’ impact on Americans’ collective psyche is vast.

For most investors and speculators, this is pretty obvious.  When the stock markets are up we feel more optimistic about everything, so we tend to spend more.  Economists call this the wealth effect.  And when the markets are down we feel more anxious and worried, so we pull in our horns.  Not surprisingly, these behavioral changes spawned by our rising and falling portfolios also carry over into the voting booths.

When the stock markets are strong so everyone feels better about the future, incumbents are more likely to win.  Americans perceive them as being somehow responsible for the prosperity they are experiencing and expect to continue.  But when markets are weak everyone feels worse and wants things to improve.  So the incumbents tend to get booted out in favor of the challengers.  The stock markets are the key.

Provocatively much hard data supports this thesis, it is somewhat well-known among students of the markets.  Back in February the same day I published my original essay in this series, another fascinating thread from a different perspective also made news.  InvesTech Research did a study showing that stock-market performance has been the most reliable indicator of who will win the presidency for over a century.

The methodology was simple.  InvesTech looked at the stock markets’ performance in the 2 months leading up to every US presidential election since 1900.  Since these elections are held on the Tuesday after the first Monday in November, always early that month, this essentially means how the markets did in September and October.  This minor piece of data has correctly forecast nearly 9 out of 10 elections!

 

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InvesTech found that if the stock markets rally to gains in the 2 months leading into elections, the incumbent party wins the presidency.  And if the stock markets slump to losses in that critical September-October period for shaping psychology, the incumbent party loses.  Out of the last 28 presidential elections, this simple indicator has proven correct 25 times.  This is an astounding 89% success rate!

Broken down further, in 15 out of 16 times the incumbent party was re-elected to the presidency when the stock markets rallied in those final two months before voting.  And in 10 out of 12 times when the stock markets fell in September and October, the incumbent party lost.  These are super-high correlations over more than a century’s worth of data, so this stock-market indicator has to be taken very seriously.

While I sure wish I had thought of InvesTech’s elegant approach first, my own took a different tack.  I had noticed in recent years that Obama’s approval rating climbed when the stock markets were strong and flagged when they were weak.  But this was merely based on isolated anecdotal observations, reading an article or listening to a news report here and there.  Was there any way to test it more thoroughly?

Thankfully the elite polling organisation Gallup rode to the rescue.  Essentially founded in 1935, it is now probably the biggest and best polling operation in the world.  Among the countless polls it conducts, there is a daily one where Americans are asked whether they approve or disapprove of the job Obama is doing.  When this high-resolution data is overlaid on the stock markets’ performance, everything becomes clear.

Gallup’s daily job-approval and job-disapproval ratings for Obama are rendered on this chart in green and red respectively.  They are superimposed over the flagship S&P 500 stock index (SPX) shown in blue.  In general when the stock markets are up, Obama’s approval rating is high and his disapproval rating is low.  And the opposite is true when the stock markets are down.  Voters are heavily influenced by the SPX!

Starting in 2009, this chart covers both the whole post-stock-panic era and Barack Obama’s entire presidency.  But the first year or so is largely irrelevant for our purposes today.  As we’d all like to forget, 2008 suffered a brutal once-in-a-century stock panic.  The SPX ended that year down a gut-wrenching 38.5%!  So regardless if you voted for Obama or McCain, we all desperately hoped for a better 2009.

And Obama is a super-impressive guy, overcoming all kinds of hurdles including his youth and lack of experience to become the first African American president in US history.  He can give great speeches and inspire.  I certainly didn’t vote for him because his politics scare the heck out of me (Marxist class warfare and Socialist wealth redistribution), but he really had great potential to enhearten Americans.

So Obama entered office riding an incredible honeymoon high.  His approval ratings were off the chart, while disapproval ratings were low.  Even the 45.7% of American voters who didn’t want him were impressed by his charisma and sincerely hoped he could lead us out of the post-panic malaise.  This effect gradually faded over the following year as reality set in, so early 2010 is the best place to start.

After Obama’s honeymoon, as is usually the case his approval rating started to be heavily correlated with the SPX.  When the SPX surged to new post-panic highs, over half of Americans approved of the job he was doing.  But when the SPX sold off in one of its periodic healthy corrections, Obama’s approval rating collapsed while his disapproval rating surged.  This pattern has persisted for the couple of years since.

Anytime the SPX is near highs, such as in mid-2011 or early 2012, Obama’s approval rating climbed to 50%+ heights while disapproval moderated.  The best example is highlighted in this chart, the spring-2011 period when Obama’s approval per Gallup shot up around 53% while his disapproval fell near 40%.  He looked invincible then, destined to win another term.  Why?  Because stock markets were faring well.

And the opposite is true when the stock markets weren’t doing well, following major SPX selloffs.  Last autumn after the SPX’s sharp correction (which was admittedly exacerbated by Obama’s refusal to do a timely debt deal with Congress), his approval rating plunged.  It sunk all the way down into the 38% range.  And meanwhile his job-disapproval rating soared to 55%.  Americans hate weak stock markets.

Is it fair that a sitting president gets credit when stock markets rally and blamed when they sell off?  Usually not.  Occasionally some major political event comes along like last year’s debt-ceiling fight that directly impacts the markets, but for the most part investors and speculators do their own thing regardless of who is in power.  But the buck stops at the president, so he is perceived as presiding over everything.

And these stock-driven psychological swings are massive in this closely-divided country.  Remember that all elections are effectively decided by the independent voters in the middle.  About 4/10ths of American voters are conservatives who will always vote Republican, and the opposite 4/10ths are liberals who will always vote Democrat.  It is the 2/10ths in the middle, the independents and swing voters, who decide elections.

And most elections are won and lost by only a few percentage points, like 52% to 48%.  So seeing a president’s job-approval and job-disapproval ratings swinging from 40% to 55% and back based on the fortunes of the stock markets is huge.  This enormous range totally dwarfs the margins by which elections are always decided.  So obviously it really matters where the stock markets are heading into voting.

If incumbents (presidents, senators, representatives) are fortunate enough to have their fate decided after the markets have rallied for a couple months and are near major interim highs, Americans will be optimistic and much more likely to keep them in office.  But if election day happens to arrive after the markets have sold off for a couple months, then Americans are pessimistic and want new leadership.

These valuable approval and disapproval ratings from Gallup looked at through the lens of major stock-market uplegs and corrections buttress InvesTech’s approach.  What the SPX does in the September and October before an early-November election heavily influences Americans’ sentiment.  Rallying markets make Americans feel good and like their politicians, while falling ones do the opposite so they kick them out.

So if you want Romney to win this November, pray for a major stock-market slide between now and election day.  And the more that selling falls into September and October, the better.  Obama got hugely lucky in 2008.  He was down in the polls and an underdog for most of the summer, but then a once-in-a-lifetime stock panic struck at the perfect moment.  The SPX plummeted 24.5% in September and October!

That is not just a down stock market, it is a disaster.  I don’t think any incumbent, even ones commanding legendary popularity like John Kennedy and Ronald Reagan, could have won while facing such a fierce immediate psychological headwind.  It is amazing given the stock panic’s ideal timing that Obama only won 52.9% of the popular vote.  That it wasn’t a landslide shows just how polarised Americans were.

While there is no doubt in the hard data that the fortunes of the stock markets influence Americans heavily, there is a big question.  Why?  It’s obvious why investors and speculators, people who watch the markets every day, are influenced by their flowing and ebbing.  But the majority of Americans are not investors and speculators, and couldn’t care less about the stock markets’ short-term gyrations.

So why are non-interested voters also influenced?  I suspect there are quite a few reasons across multiple fronts, but a couple major ones come into play.  They include media exposure and personal relationships.  No matter how little average Americans care about the stock markets, they consume media that is obsessed with them and interact with people intimately affected by their ongoing performance.

Everyone is interested in the news to varying degrees, wondering what is happening on any given day.  And as they read articles and listen to reports, the stock markets often come up.  Any solid up day in the SPX is accompanied by optimistic and positive reporting, as everyone considers rising stock markets to be a bullish omen for the general economy.  And of course the opposite is true on any meaningful down day.

So the newsflow that people consume to shape their individual sentiment is heavily coloured by what happened in the stock markets that day.  And these trends compound over time.  Late in a major upleg Americans have been deluged with positive reports from many weeks of rallying stock markets.  So they feel good, optimistic about the future.  When things are going well there is little desire to change leaders.

And after a couple months of selling in a correction, Americans have seen plenty of negative and pessimistic reporting spawned by stock-market down days.  After enough of this, they naturally start getting worried and anxious.  So they start to look for a change in leadership to fix things, to improve the economy and their own chances for success.  If an election happens then, they like to vote in new blood for change.

And remember that the people reporting the news are not poor, and they have indirect stock-market exposure through their retirement plans.  So the media itself is part of the investor class, happy when the stock markets are strong and worried when they are weak.  These innately-human biases of reporters naturally spill into their work no matter how hard they try to be objective.  And many don’t even try.

Personal relationships are the second biggest reason the SPX is so influential after media exposure.  About 90% of Americans work in the private sector.  And of course the companies that employ them need to earn profits by making sales.  Since the stock markets drive such a huge wealth effect, people spend more when they are doing well and less when they aren’t, sales naturally follow the stock markets too.

When sales are weak, owners and managers get anxious and worried.  Their employees can’t help but notice this pessimistic bias and quickly internalise it as their own, even if they don’t know the exact cause.  They too grow increasingly nervous, fearing for their jobs if operations are cut back to bring costs back in line with reduced revenues.  So employees are indirectly influenced by the stock markets.

These relationships extend into our personal lives too.  We all frequent businesses to buy the goods and services we need and want.  Many of these are small businesses.  Sales are the lifeblood of small business, and when you visit one there are often clues about how business is going.  When it is well, more likely in up markets since Americans spend more, the vibe is usually positive and optimistic.

And the opposite is true when business is slow.  When we see businesses appear to be struggling, we start worrying about the economy too.  In addition, the majority of Americans probably have close personal friends who are small businessmen or investors.  So when they talk to these friends who are influenced by the state of the stock markets, some of these views naturally rub off on them as well.

One of the most famous political phrases in modern history was created by Bill Clinton’s notorious campaign strategist James Carville.  “It’s the economy, stupid.”  This slogan helped unseat Bush the Elder as Americans were worried about a weak economy.  Americans really do vote with their wallets, and strong stock markets make people feel secure while weak ones make them feel anxious.  Elections reflect this.

There is a high probability that the state of the stock markets heading into early November will decide the US elections this year.  We like to think there is a choice between pro-big-government Obama and pro-free-market Romney, and we do.  But Americans are so heavily influenced by the stock-market fortunes in a variety of ways that they generally aren’t even aware they’re often dominating their sentiment.

The future path of the US hangs in the balance, and the stock markets could effectively decide its fate!  So if there was ever a time to get up to speed on the markets, what is happening and what is likely to happen, now is it.

The bottom line is the short-term fortunes of the US stock markets nearly always determine the outcome of our presidential elections.  When the markets are up, Americans feel optimistic and are more likely to give the incumbents more time in power.  And when the markets are down, we get pessimistic and want to give the challengers a chance to improve things.  This has proved true for over a century now.

Nothing influences our collective national psychology more than the state of the stock markets.  This is even the case for Americans who don’t directly invest due to media exposure and personal relationships with those affected by the markets.  Americans are going to vote their wallets this year as always, and how they feel about the economy and their futures will be heavily coloured by how stocks are faring.

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