Across My Desk: The Schwab Report's special election edition

"CAN THE MARKET PREDICT THE PRESIDENTIAL ELECTION?
Ken Tower, chief market strategist, CyberTrader

"In price, there is wisdom," is a famous quote from long-time market analyst Alan Shaw. The price action of freely traded markets contains information about the balance between the forces of supply and demand. This underlies many well known Wall Street adages such as "the trend is your friend" and "don't fight the tape." Investors are humans, and humans are emotional.

Because voters are also emotional humans, we may apply some of the same tools technicians use on the stock market to presidential politics, in order to make an educated guess about who will become the next president.

A HISTORICAL LOOK AT INCUMBENT CANDIDATES:

1. THE INCUMBENT PARTY WINS APPROXIMATELY TWO-THIRDS OF THE TIME. It is difficult to unseat the incumbent, not necessarily the individual candidate as much as the party in power. During the last 104 years, there have been 26 presidential elections. In 16 of those, the party in power gained re-election; in some, the president was re-elected, while in others a candidate of the same party was elected.

2. AS THE MARKET FALLS, SO DOES THE INCUMBENT. Of the ten elections that the incumbent party LOST, six of them coincided with the Dow falling or posting only a modest gain since the prior election. The most obvious example of this is Hoover's 1932 crushing defeat by Roosevelt. Hoover won the 1928 election, retaining Republican power in the White House, with the Dow finishing the month of October 1928 at 252.16. Just prior to election day of 1932, the Dow had fallen to 61.90, 75 percent lower than it had been when Hoover was elected.

With the economy in a shambles, it was no wonder the electorate wanted a change. The decline in the Dow was symptomatic of a decline in the nation's overall economic well being. It does not require a tremendous decline in the Dow to trigger an emotional reaction on the part of voters. Americans appear to have high expectations about growth so it takes only a disappointment to sink a candidate.

3. WHAT HAVE YOU DONE FOR ME LATELY? The remaining four elections are some of the closest, most contentious and memorable election campaigns. They are the elections of 2000, 1992, 1960 and 1952. In each case, the incumbent party came into the election with the Dow at least 20 percent higher than at the prior election, which would appear to give them a decided edge. However, in each case, the challengers won.

In three of these four cases, the candidate running was not the incumbent President (1992 Bush versus Clinton is the exception). So it appears that running in the shoes of the incumbent is more difficult than being the incumbent himself. But the market also has something to say here: It would appear that voters have a bit of a "what have you done for me lately" attitude.

In the 1960 election (Nixon versus Kennedy) the change in the Dow for the year before the election was negative 10.24 percent. As the election approached, the Dow was over 20 percent above where it had been at the previous election in 1956, but 10 percent below where it was at the end of October 1959. This poor performance in the FINAL YEAR ahead of election is also found in the other three cases where the incumbent party lost despite the Dow's having advanced strongly over the prior four years.

THE CURRENT ELECTION OUTLOOK:

At present, the Dow is nearly 900 points, or 7.7 percent below the 10,971 at which it closed at the end of October 2000. We noted earlier that anything less than a 20 percent advance removed much of the incumbent's advantage. That 20 percent advance translates into 13,165, so any number below that points to a competitive election. As for our third component -- market performance in the year ahead of the election -- the Dow (presently 10,125) is now just 3.3 percent above its October 2003 close, again eliminating the incumbent's advantage. And this election indeed appears to be a horse race!

The poor market action, reflecting a troubled period in the economy, has stripped the incumbent of any "economic breeze" at his back. Of sitting presidents, only FDR (in the elections of 1936 and 1942) was re-elected with worse market performance than the president has today.

THE BOTTOM LINE:

With the election hanging in the balance, market action in the next few weeks prior to the election could prove decisive in swaying those few remaining undecided voters."