October 9th, 2012 | Forbes
Roosevelt, Reagan, Clinton and…Obama?
Last month I was honored and delighted to participate in the annual meeting of the Academy of Behavioral Finance & Economics, held in New York City. The field of behavioral finance is a particularly fertile one, and at the meeting academics and researchers from around the globe presented hundreds of interesting papers on a myriad of topics.
One area that particularly interests me is the link between social mood and market performance. I recall that a few years back one of our research partners and my good friend Phil Maymin, professor at NYU Poly, produced a paper demonstrating the interplay between public mood, music and market volatility [i]. At last month’s conference, an academic from the Copenhagen Business School spoke on the connection between (American) celebrity deaths and investor sentiment. Robert Prechter, head of Socionomics Institute, which studies social mood’s impact on everything from finance to fashion, gave an intriguing presentation[ii] on the relationships between social mood, stock markets and US Presidential elections. Since we have one approaching, I thought it would be timely to summarize and share some of his findings.
Public Mood and the Markets
This statistical research, which goes back to the 18thcentury, demonstrates a strong relationship between an incumbent President’s vote margin and the prior three years’ net percentage change in the stock market. In fact, the research shows that stock market performance has through history been a much more accurate predictor of an incumbent’s re-election results than key economic data such as GDP growth, unemployment and inflation rates.
Here’s how the relationship works. The study posits that it all starts with social mood, a “hidden, independent variable” that is defined as “the aggregate, unconscious levels of optimism and pessimism in society.” Next, stock market indexes reflect social mood, in effect responding quickly to changes in social sentiment.
Finally, the re-election or rejection of incumbent Presidents closely follows public mood-linked market performance. “Voters unconsciously credit or blame the leader for their mood.” The research studies all Presidential elections and found strong evidence that an increasingly positive social mood, expressed by a rising stock market, will positively influence an incumbent’s re-election prospects; an increasingly negative mood, indicated by a falling market, negatively influences those prospects. Moreover, a strong stock market gain presages a landslide victory for the incumbent president; a sharp market decline ordains a landslide defeat.
Markets and Presidential Landslides
For his test, the study used the three-year period from November 1 of the year after the previous election through October 31 of election year based on the logic that society tends to judge a President by change during the bulk of the presidential term, while assigning credit or blame for the start of the first year to his predecessor. From 1896 the study used the Dow Jones Industrial Average (DJIA) as the market proxy, and other available indexes prior to 1896. The research defines a large positive stock market change during the three-year span as equal to or greater than 20%; a large negative change is a market decline of 10% or more. It studied elections from 1792-2004 and found a very high correlation between large market movements and election results.
For example, when the DJIA advance pierced the 20% threshold (or declined by 10% or more), in 94% of cases the incumbent won by a “landslide” margin of 20% of electoral votes or more (or an incumbent lost by a margin of greater than or equal to 10%). Bull markets are also strongly associated with incumbent “landslides” of a 10% or greater margin in popular votes (and bear markets with an incumbent losing the popular vote by 5% or more). By criteria such as these, strong stock markets accurately foretold the landslide victories of incumbent presidents including Franklin Roosevelt (1936), Eisenhower (1956), Reagan (1984) and Clinton (1996).
The study stops with the 2004 election, but we can’t help but extend the methodology to next month’s presidential election, where we again have an incumbent, President Obama, running for re-election. The polls between the President and Mitt Romney are close, but by this study’s method, the social mood as reflected in the stock market, seems to imply a landslide victory for the incumbent: from November 1, 2009 to September 28, 2012 the DJIA rose by 50%. In just a few weeks’ time, we’ll be able to again put the robustness of this model to the test. In closing, I should note that none of these studies of social mood and markets is precise, but they do demonstrate how our mood influences our decision-making, and that not all choices we make are made mathematically—a familiar concept to students of behavioral finance.
Research shows that stock market outcomes are a more accurate predictor of incumbent presidents’ re-election chances than many closely watched economic indicators. Voters vote according to trends in social mood, which is expressed in stock market performance. Large stock market gains are strongly associated with landslide election victories for incumbent presidents.
As Published On: Forbes
[i] Music and the Market: Song and Stock Volatility. Maymin, Philip. 2007.
[ii] Social Mood, Stock Market Performance & Elections. Prechter, Robert R.; Goel, Deepak; Parker, Wayne D.; Lampert, Matthew. Socionomics Institute, 2012.
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