Listen to the political pundits and pollsters if you must, but to predict who will win this year’s presidential election, you may also want to keep an eye on the stock market.
When stock prices rise in the months before an election, the incumbent party usually stays in office. When they fall, a new party most often moves into the White House.
Only twice since 1900 has a party stayed in office when the Dow Jones industrial average was down between late August and the election, historians say.
“There is quite a remarkable correlation between what party wins the election and what the Dow does from late August after the party conventions to the November election,” said Yale Hirsch, editor of the Stock Trader’s Almanac. “The incumbents mostly lost when the Dow went down during this period.”
Most recently, a stock market decline of 1.3 percent in 1992 foretold defeat for President George Bush and victory for Bill Clinton. Then, as an incumbent, Clinton coasted to victory over Bob Dole in 1996 with a 7 percent gain in the stock market.
But don’t bet your retirement on the election-year odds. Hirsch said the incumbents probably should have lost in 1948 and 1956 when the market dropped, but unusual circumstances intervened to keep them in office.
In 1948, President Harry Truman just “worked much harder and outcampaigned” an overconfident Thomas Dewey. Also, the market was down only slightly, 0.5 percent.
Dwight Eisenhower had no trouble holding the office in 1956 because he was still a beloved World War II general, and the stock market was down mainly because Russian tanks had rolled into Hungary.
The market usually rises before presidential elections. In the last 50 years, the Standard & Poor’s 500 index has never recorded a loss in the last seven months of election years.
That may be one incredibly lucky coincidence for the ruling parties. But most market experts said the incumbents have learned how to juice up the economy, which inevitably raises stock prices.
Jim Weiss, chief investment officer at State Street Research in Boston, said one of the key reasons the market rises in election years is because of accelerated federal spending. While Congress appropriates the money, the executive branch spends it.
In other words, the House and Senate may pass a bill authorizing the building of a new aircraft carrier, but the money isn’t actually spent until the Defense Department awards the contract.
“All sorts of programs have been appropriated, but the spending has lagged,” Weiss said. “So the president sends out the word in election years to spend it and get rolling.”
Additionally, the Federal Reserve is reluctant to tinker with short-term interest rates during the latter half of an election year because it doesn’t want to be perceived as trying to influence the election toward one of the parties, said Henry Hu, a University of Texas professor and Wall Street expert. This means the market can take solace in the fact that stocks won’t have to face a headwind of higher interest rates.
Finally, successful incumbents tend to “minimize trouble” during election years, Weiss said. For example, a pressing problem overseas is shoved aside or dealt with quietly to at least give the appearance that things are running smoothly. This is soothing to the stock market, which doesn’t like foreign upheaval and surprises.
It’s still much too early in the campaign for anyone to know who the eventual winner will be. Wall Street typically doesn’t start paying much attention to the race until after the first debate in the fall, when the candidates’ positions have hardened.
Then, investors who stay abreast of these issues can sometimes make smart stock plays in sectors affected by the positions that candidates take, said Andy Engel, research analyst at the Leuthold Group in Minneapolis. For example, if both candidates decided to embrace the notion of for-profit education, then stocks in that sector, such as Apollo Group Inc. or Education Management Corp., might soar.
Conversely, the Democrats may start beating up the Republicans over the issue of, say, prescription drug prices. To counter the political damage, Republicans may decide they also have to get tough on the pharmaceutical companies. In that political environment, investors probably should steer clear of pharmaceutical stocks.
“There is the potential in any election for individual industries to be helped or hurt,” Weiss said. “The market is very interested when candidates take positions at the industry level.”
While some people may be tempted to use election-year stock market statistics and campaign promises as an investing strategy, Hu advises against it, calling it much too simplistic an approach.
“The market often seems to show consistent patterns only to have them fall apart unexpectedly,” Hu said.
If the Fed determines later this year that inflationary pressures are too worrisome, it may feel compelled to raise interest rates despite the coming election, and that could have a negative effect on the market, Hu said.
“Just remember, there are no easy free lunches, that is, no easy, sure-fire money-making opportunities in the stock market,” he said. “Investing in stocks simply because stocks have tended to go up in election years, regardless of what stock valuations may be, is to ignore this fundamental principle.”
