If you want to know who’s going to win in November’s US presidential election, just look at stocks.
According to Daniel Clifton at Strategas Research Partners, the S&P 500 has correctly “predicted” the winner of the presidential election 19 of the last 22 times.
In this case, the “prediction” method is simple: If stocks are higher over the three months ahead of the vote the incumbent party wins; if stocks fall over this period, a new party wins the White House.
So presuming we have a race with Hillary Clinton representing the Democratic Party and Donald Trump on the Republican side, if stocks rise between August 8 and November 8, 2016, Clinton wins.
Otherwise, we’ll have President Trump.
Intuitively, this trend makes sense. If the economy is weakening, stocks should be declining and the incumbent party will likely suffer. Moreover, should it look like a new party is to take control of the White House, the change in control could add uncertainty to investors until the new President gets his or her rhythm.
In fact, we have found that “open” election years, a year in which no incumbent is up for re-election have been tougher for stocks than presidential reelection and non-presidential election years. Interestingly, stocks have rallied in the past two (and rare) instances when a political party has received a 3rd term.
The S&P 500 increased 30 and 27 per cent respectively in the year after Harry Truman won in 1948 and George H.W. Bush won in 1988. Sometimes the devil you know is better than the devil you don’t know.
So, as Clifton notes, there’s a little bit of a chicken-or-the-egg thing going on here. Stocks tend to react to trends in the economy: investors pay more for stocks if expectations of future earnings increase and pay less of these expectations fall.
The presidential race, in turn, tends to react to economic trends as voters feeling good about current and future prospects tend to favour incumbent candidates and their parties while reversals of economic fortune likely lead voters to seek change.
In this way, maybe it isn’t so much that stocks “predict” the election outcome as stocks tend to reflect the economy’s overall trend, which in turn affects voters’ decision making.
Which in a way brings us back to one of the most famous axioms in politics: “It’s the economy, stupid!”