Post-Election Markets Can Predict the Economy's Course
This kind of guessing game may miss a deeper truth. There’s some evidence that the behavior of the stock market in the days after an election can, under certain circumstances, predict the rate of economic growth for the remainder of the president-elect’s administration.
This, at least, is the hypothesis of a study published in the somewhat obscure Journal of Economics and Business Research. The academic authors -- Wen-Wen Chien, Roger Meyer and Zigan Wang -- gathered data on presidential elections going back to 1900, when President William McKinley won re-election. They tracked the behavior of the Dow Jones Industrial Average the day after elections, as well as the index's cumulative performance over the subsequent week and month.
They found that, when it came to the early 20th century, the stock market’s performance after presidential elections wasn’t all that predictive of the economy's direction.
But starting in 1936, the snap judgment of the markets began exhibiting a bizarre pattern that held until 1988. In every presidential contest, the stock market’s response the day after Election Day was negatively correlated with future economic growth: a rally the day after would be followed by four years of recessions and subpar growth; a sell-off would be followed by strong GDP growth. In other words, the stock market was consistently, reliably, wrong.
But in the late 20th century, the dynamics shifted. After the election of George H.W. Bush in 1988, the correlation turned positive for the first time. The stock market went down the day after his election, and his administration’s GDP numbers proved pretty abysmal. Since then, the correlation has become stronger -- and has been positive in every election through 2008. Rallies mean growth; declines are genuinely a bad omen.
Why? The authors of the study don’t speculate, though it’s intriguing that the negative correlation surfaced during the New Deal, when government first began playing an outsize role in the larger economy. Then, once the Reagan Revolution came of age, the nature of the correlation flipped into positive territory, where it remained through the election of Barack Obama in 2008.
In 2012, that pattern didn't hold up. Obama handily won re-election, but was greeted with boos on Wall Street, with a whopping 313-point sell-off. And then the economy registered quarter after quarter of solid growth for the next four years -- hardly the recession that the stock market seemed to signal.
Was this result an outlier? Or did it signal that the waves of correlation had shifted yet again into negative territory, indicating that the stock market was reliably and consistently misinterpreting the results of a presidential election?
We may get our first hint of an answer after markets open on Nov. 9. But whoever wins, we’ll have to wait until 2020 to learn if this arcane hypothesis still holds up.
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