Renowned economic theorist Robert R. Prechter, Jr.
describes why the stock market is a good predictor of presidential
elections. What’s the prognostication? Read on. Most likely you won’t
lose a bet.
Most statistical studies in the field of political science test whether A
causes B. With respect to election outcomes, for example, researchers
test things such as which party in power is better for the economy, or
whether the state of the economy predicts which party will get elected.
Sometimes results seem meaningful, but when the test time period or the
economic variable is changed, the apparent significance often
disappears. Generally, results have not been very useful.
My colleagues at the Socionomics Institute and I set out to test
something different and more difficult. Socionomic theory proposes that
unconscious social mood regulates social actions. For example: In the
field of finance, social mood regulates aggregate pricing in the stock
market. In the field of politics, social mood is a strong regulator of
which leaders are selected and how they are perceived. Specifically,
when the trend of social mood is positive, investors tend to bid stock
prices higher and voters tend to retain incumbent leaders; when the
trend is negative, investors tend to bid stock prices lower and voters
tend to oust incumbent leaders. In other words, our theory is that C
(social mood) causes A and B.
But C"social mood"is a hidden variable. We can’t measure it directly by
hooking up electrodes to 200 million human brains. We can measure only
the
effects of social mood, as expressed in social actions. With this hurdle, how could we test our idea?
We first set out to test our hypothesis that the stock market should be a
useful indicator of whether voters retain or reject an incumbent. Since
pundits tend to credit or blame the predecessor for conditions during
the first year of a new president’s term, we suspected that the
performance of the stock market three years prior to the election would
be the best duration for testing how voters would judge an incumbent.
Nevertheless, for robustness, we tested stock market returns for
durations of one to four years before each election.
To assure further robustness of results, we tested the stock market’s
performance against multiple measures of voting results: popular vote
margin and percentage, electoral vote margin and percentage, straight
win/loss, and landslides (both electoral and popular vote). We tested:
Various thresholds to judge landslide wins and losses
Percentage and lognormal changes
Stock market returns using both nominal and inflation-adjusted prices
Also, we subjected the data to four different types of statistical
tests, and we used all available data, going back to 1824 for popular
vote and to George Washington’s reelection in 1792 for electoral vote.
We found that the stock market is significant predictor of election
results in all cases. As surmised, the best result was the three-year
period prior to the election. One of our landslide tests obtained a
perfect score.
While useful, this result did not answer our primary theoretical
question. After all, maybe the stock market is just one of many
conditions by which voters judge a president’s performance. In other
words, perhaps there are many A’s, but A still causes B.
Conventional wisdom says, “It’s the economy, stupid.” But socionomic
theory predicts that the stock market would be a better register of
social mood than the economy. The reason is that investors can express
social mood nearly instantaneously by buying or selling stock, whereas
it takes time for business people to implement business plans formulated
at the same time.
So, we next set out to test how the stock market compared to the economy
as a predictive variable. If the economy performed as well as the stock
market, then we still had a useful result, but not one that is
theoretically important.
To assure robustness, we tested the predictive ability of the so-called
“big three” economic indicators: gross domestic product (GDP), inflation
rate, and unemployment rate. We also tested inflation-adjusted (real)
GDP. We tested these variables individually and in combination with the
stock market.
We found that the stock market outperformed every one of the economic
variables, on all four time frames. Indeed, in our tests, inflation and
unemployment showed no significant ability to forecast election
outcomes. GDP was a significant predictor, but its stand-alone
predictive ability was weaker than the Down Jones Industrial Average
(DJIA), and its significance disappeared in the presence of DJIA,
whereas DJIA remained significant in the presence of other economic
variables.
This counterintuitive result got us closer to our goal of demonstrating
socionomic causality. After all, it would be difficult to claim in this
instance that A caused B (i.e., that the stock market
caused voters to retain or reject an incumbent president). Why would voters
care more about their portfolios than about their jobs, their savings
and their country’s economy?
Nevertheless, economic-voting theorists could still claim that for some
unknown reason, voters care more about the stock market than about the
economy, the inflation rate or the availability of jobs. In other words,
A still causes B.
So, we did one last test. If voters truly are voting in response to
their stock market gains and losses, then our results should be stronger
in times when more voters own stock. To test whether this is the case,
we bifurcated our results.
In the first half of the 20th century, few Americans owned stock;
estimates for different decades during that time range from two to 10
percent of the population " the latter number appearing briefly, near
the 1920s stock market peak. Conversely, in the second half of the 20th
century, up to 50 percent of American households owned stock. Yet we
found that the predictive value of the stock market was about the same
in both periods. Ownership didn’t seem to matter.
For added robustness, we also tested the two centuries against each
other. In the 19th century, most Americans were farmers. Almost no one
owned stock. Yet the stock market remained a significant predictor of
re-election outcomes in both the 19th and 20th centuries. In fact, the
record for the 19th century is actually slightly better than that for
the 20th century!
Clearly,
A cannot be causing B. Voters are not deciding to keep
or reject incumbent presidents simply because they are making or losing
money in the stock market.
The socionomic explanation holds: Voters in the aggregate are not
responding to stock market changes, economic changes, inflation rates or
the availability of jobs. Rather, they are voting in accordance with
socionomic theory, which proposes that both investors and voters are
acting in accordance with a
hidden variable: social mood. In other words, C is causing both A and B.
We believe our study helps demonstrate that aggregate voting at the
margin"swing voters"are not so much rationally weighing the potential
value of each candidate but rather voting primarily based on how they
feel.
When a positive trend in social mood induces investors to push the
stock market upward during the three years prior to an incumbent’s
re-election bid, it also induces voters to credit the incumbent for
their good moods and vote to retain the incumbent in office. When a
negative trend in social mood induces investors to push the stock market
downward during the three years prior to an incumbent’s re-election
bid, it also induces voters to blame the incumbent for their bad moods
and vote to reject him from office.
Our study has practical value for election forecasters: To improve
long-range prediction of election outcomes, use social-mood indicators
in your mix. We have some advice for politicians, too: If you want to
beat an incumbent, make your initial bid for office when the stock
market has fallen a long way. If you are already in office and the stock
market has risen a long way, run for re-election; if it has fallen a
long way, bow out gracefully, take a respite, and keep a humiliating
defeat off your resume.
Republished from
Industry Today
Author Robert R. Prechter, Jr. is an economic theorist who founded
the Socionomics Foundation and serves as executive director of the
Socionomics Institute. Based in Gainesville, Ga., the Institute analyzes
social mood and its role in driving cultural, economic and political
trends. Article content comes from the paper “Social Mood, Stock Market
Performance and U.S. Presidential Elections: A Socionomic Perspective on
Voting Results,” which Prechter co-wrote with colleagues Deepak Goel,
Matthew Lampert and Wayne Parker. It is available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1987160. To read more
about socionomic theory, visit the Institute’s website at
www.socionomics.net. Mr. Prechter is also president of Elliott Wave International (ElliottWave.Com)
