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Confusing Cause & Effect: Elections and Markets

Its an election year, and that means sophistry and ignorance in equal measures will be flooding the airwaves and intertubes.

We have taken it as our charge here to fight against the logically challenged and the factually incorrect. We addressed this exact issue four years ago, but given the propensity us Humans have for self-delusion, we must crank up the wayback machine, and review some basic economic and logical truths.

The latest meme making the rounds -- I've seen it in the WSJ, on Kudlow's show and read it online -- is a move to blame the recent market turmoil on the rise of Obama at InTrade, or to correlate the sell-off with the declining polls for the incumbent party.

The WSJ fell prey to this same reasoning:

"Worry about possible policy changes can weigh on markets ahead of a presidential vote. If an incumbent seems likely to win, markets often recover by the fall. This year, with many of the candidates on both sides promising change, the risk is that the market jitters could linger."

Markets do not recover because the incumbent seems likely to win; rather, the underlying conditions that work to the advantage of markets -- robust growth, brisk consumer spending, job creation, income gains, tame inflation, etc. -- also work to aid the incumbent.   

Consider the following chart, via Ned Davis Research:
click for bigger graph

>
We all fall under the spell of faulty logic sometimes, confusing what is cause and what is effect. As another example of this, consider the following:

"Obama is currently the presidential frontrunner. Note that, on Intrade, the market odds of an economic recession in 2008 are rising in tandem with the odds that Obama will be elected President. Correlation does not prove causation but this correlation is worrisome."

All too often, we see the cause and effect relationship analyzed exactly backwards, as in the above example. These causative errors are an all-too-common analytical blunder when reviewing market or economic data. Unfortunately, in seeking certainty in an uncertain world, confusing cause and consequence is an all-too-regular occurrence. The above quote is a perfect example of that foible.

To review: Markets are not skittish because the incumbent party is in trouble - that’s getting it ass-backwards. When the ruling party is in election trouble, its because the future discounting mechanism of markets is incorporating a slowing economy into its pricing. Markets may be imperfect and subject to the excesses of crowd behavior, but they eventually get the big picture correct. The current market malaise reflects a recognition what is occurring in the macro-environment.

In the present case, its a weakening economy and the prospect of decreasing earnings that is most impacting equity prices. Slowing industrial production, a weak dollar, faltering consumer spending, high inflation, and $100 oil, weakening job creation and real income losses are factors that impact equity prices -- and the electorate -- invariably hurting the incumbent party's election fortunes.

People who are content with the status quo and secure in their financial futures vote for more of the same; when they are not, they vote for change.

Thus, the Cause is the weakening economy and its discontents thereto. The Effect is the rise of candidates claiming to be change agents, and fall of those representing the status quo.

Want to see a good example of how politicians recognizing this economic discontent (aka "Cause") ? Look at how often members of the incumbent party use the word "change."

I'm a political independent -- I supported McCain in 2000, and I would support a technocrat like Mayor Bloomberg today -- but these arguments all smack of partisan cheerleading to me. I even recall back in 2004 that the same faulty argument was made in a WSJ editorial: "Kerry Up, Markets Down." The Obama claim appears to me to be more of the same . . .

~~~

One final thought: Its even more spurious to rely on Intrade as a source of what is roiling markets. The presidential and political predictions markets are notoriously unreliable, especially far in advance of actual elections. But its not just far in advance: Recall how wrong the prediction markets were with Howard Dean and Iowa, and with the GOP retention of the Senate in 2006.

As of yesterday, the Intrade bet for Obama to win New Hampshire was over 95% -- Whoops!:   

Final settlement: Obama to win NH expired at 0.0.   

To quote Dan Gross, these are "less futures markets than immediate-past markets."

In an upcoming post, we will review the strengths and weaknesses of these thinly traded prediction markets . . .

>

Source:
Campaign Talk Gives Market Further Jitters
Promises of 'Change,' Economic News Blend To Unsettle Investors
E.S. BROWNING
WSJ, January 7, 2008; Page C1
http://online.wsj.com/article/SB119966775786271209.html

Logical Reasoning Errors: The Dow Election Year Cycle 
The Big Picture, Thursday, August 12, 2004 | 07:14 AM     http://bigpicture.typepad.com/comments/2004/08/dow_election_ye.html

Obama, the Election and the Economy
Jonathan
Chicago Boyz, January 6th, 2008
http://chicagoboyz.net/archives/5470.html

Iowa and Prediction Markets
The Big Picture, January 24, 2004 | 11:15 AM    http://bigpicture.typepad.com/comments/2004/01/iowa_and_predec.html

WHY WERE THE POLITICAL FUTURES MARKETS SO WRONG ABOUT OBAMA AND CLINTON?
Daniel Gross
Tuesday, Jan. 8, 2008, at 10:12 PM ET   
http://www.slate.com/id/2181745/

Wednesday, January 09, 2008 | 06:25 AM | Permalink | Comments (33) | TrackBack (1)
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Comments

I'm just happy that it's not "Republican Ken"(Mitt) Vs. "Democrat Barbie"(Hillary.

That would just be a Snoozer into november.

hey the futures are up, the market must like Hillary.(that horseshit is some of the most backwards thinking ever.)

Posted by: Eric Davis | Jan 9, 2008 7:00:25 AM

In a stunning upset, and to the chagrin of the media, Hillary topped Barack in the New Hampshire Primary by three percentage points. Independents are allowed to vote in either party’s primary. They voted heavily for McCain and Obama. Ergo Hillary did enormously better than expected – provided the computers are legit.

The surprise result compels us to recall some important tenets of the electorate that
the late Al Sindlinger espoused.

1) Barring a major war, Americans vote their pocketbook.
2) The next consideration is ‘likeability’.
3) National minority candidates poll better than the actual results because people don’t want pollsters to perceive them as anti-minority.

Posted by: Bill King | Jan 9, 2008 7:26:25 AM

If the markets were up during an election year in which there was a Democratic incumbent, you can bet that the Wall Street Journal would be trumpeting that "the markets are up in anticipation of the Republicans taking the White House in November."

Their reporting reflects an ideological partisan bias.

Posted by: OkieLawyer | Jan 9, 2008 8:04:15 AM

You know, BR, they still interview that moron that "created" the Super Bowl stock market indicator--the all time great causation/correlation vs. two totally unrelated data series act of stupidity.

The Obama thing is ridiculous---since it means that Lady MacBeth is doing better. I would hope the market would do better if Obama does well, not worse.

Posted by: Jay Weinstein | Jan 9, 2008 8:07:35 AM

Economic cycles and political cycles are co linear not causal.
The late great Herman Kahn pointed this out in his 1981 book "The Coming Boom." Think about the 1981 economic and political conditions.
I sorely miss that old fat man. It has been said that Stanley Kubrick modeled Dr. Strangelove after Herman.

The book is still a must read in my opinion if for no other reason than his take on world demographics.

I awoke this morning and the sun came up. Damn I'm good!

Posted by: Ross | Jan 9, 2008 8:26:26 AM

Ross:

the sun hasn't come up here yet.....

we need to be contrarian, and challenge our assumptions...

(I'm not taking issue, more making a joke)

Posted by: Eric Davis | Jan 9, 2008 8:38:09 AM

With a weakening economy a Democratic candidate's chances of winning are great. Losing the 15% tax on stock dividends reverting back to 28+% is almost a certainty if either of the Democratic candidates win. This would lower the attractiveness of common stocks and drop the value of the total stock market by, say 10%.
Where am I wrong?

Posted by: Steve C | Jan 9, 2008 8:46:24 AM

"1) Barring a major war, Americans vote their pocketbook."

Yes Bill and BR are correct.

Here in Atlanta, a city of 5.5 million, where 40,000 jobs are forecast to be created in all of 2008, we find this in today's AJC, "They came in droves — high school students, retirees, young moms, the unemployed — all for a shot at a job at a new Wal-Mart on Memorial Drive in central DeKalb County.

In just two days, and with virtually no advertising or even any signs, a staggering 7,500 people filled out applications for one of the 350 to 400 available jobs."

7500 people show up at WalMart for as yet, unadvertised jobs.

Something is up and people are not happy.

The US now has the most deaths from treatable diseases, privacy on par with China, Russia, and Cuba. The S&P has averaged 3.2% the last 10 years.

Its time for change.

Posted by: me | Jan 9, 2008 9:10:20 AM

After the past 7 years, it's astounding that the Republicans (conservatives - Oy!) still try to claim the mantle as the Party of and for Business.

I guess the "faithful" (Oy! again) will ride this stock to the bottom.

The total value of the dollar, the Stock Market, and most hard assets has dropped at least 10%, and will drop much more than that, based solely on the shenanigans of the current Republican administration and immediate-past Republican Congress.

No matter which party the next President belongs to, it will be very difficult to recover from the "CEO Presidency".

Posted by: Marcus Aurelius | Jan 9, 2008 9:18:22 AM

The overall cycle for the next few years is one of *contraction*. A major economic shift like this will manifest in a change in political sentiment.

Posted by: Deborah | Jan 9, 2008 9:30:53 AM

Watch the smooth shift of responsibility for all "bad" things from the past Democratic president to the possiblility of the next Democratic president.

The last 10 years of Republican controlled congress and 8 years of Republican president are entirely neglible and hold no reponsibility for the screwed-up state of things. No sir! Not at all!!

Posted by: Neal | Jan 9, 2008 9:33:28 AM

And, Steve, have you read anything in the past few months about a tapped out housing market, falling CRE, credit contraction, high oil prices, job losses, over-extended consumers, rising foreclosures, dropping dollar, rising gold, etc., etc..

But I'm sure the possibility of something happening two years out if a Democratic candidate is elected is far more important than any of those immediate market factors.

Posted by: Neal | Jan 9, 2008 9:40:55 AM

While "change" is the buzz word for the primaries, I would venture to guess that the phrase, "It's the economy, stupid" will be front and center in the national race. With more focus on the economy, and considering its weak state, there is little positive energy to be found... especially considering the fact that "change" does not often translate as a positive word, at least in the short-term, as pertaining to the psyche of investors...

Posted by: The Financial Philosopher | Jan 9, 2008 9:42:01 AM

Larry Kudlow and the WSJ would say nearly anything to further the cause of the Republican party. Being surprised that either claims Democrats are bad for the economy is like noticing the sky is blue and expressing amazement at the discovery.

On a different note, some sectors are starting to look good. I think a bottom is near. This is not to say markets will immediately return to new highs. Rather, it will soon be safe to jump in the water. Probably late January. More damage is ahead before that.

I don't think a recession is here or coming soon. If one were imminent, there would be more bad news, such as huge layoffs. Rather, all we hear are finance babies screaming, pundits trying to fill air time and print, and other disappointments. The stock market is only reverting to mean, bleeding off the bubble of recent date.

Unless the coming recession will be a death by 1000 cuts, there is not one on the horizon. Other than subprime, show me a good hammer hit and then I will reconsider my statement.

Posted by: cinefoz | Jan 9, 2008 9:59:31 AM

>>If one were imminent, there would be more bad news, such as huge layoffs.>>

Does it occur to you that may be these companies that have been "adding jobs for 52 straight qtrs." are now a victim of the current methodology that is used by this administration??

As to say "all those jobs we created" are not really that impressive since, in my view, those would be the first people to hit the street. The financials are really the only industry that added people at such a furious rate (and almost up to and including July of this year they were still hiring)

So what I am really saying is the reason we have not seen layoffs at a higher rate is that the BLS model is so woefully inaccurate that those jobs are (along with several things) are a fabrication of this administration.

Just as the market was bullied up to new record highs on nothing more than rhetoric and hope......we are seeing that same pattern repeat itself in other measurable data points. The brokers and banks knew what was coming so why not use the power they have to allow a large cushion as asset sales start to take place. That is what is happening now. Still above the August lows...my guess is that baring some major piece of news it will stay above it.

Ciao
MS

Posted by: michael schumacher | Jan 9, 2008 10:13:00 AM

Hey, "me":

You wrote: "7500 people show up at WalMart for as yet, unadvertised jobs."

This is nothing new. In early 2006, look what happened in a suburb adjacent to Chicago:

"(Crain's) — The new Wal-Mart Stores Inc. location opening Friday in suburban Evergreen Park received a record 25,000 applications for 325 positions, the highest for any one location in the retailer’s history, a company official says."

Of course, the lunatics who run Chicago have done everything in their power to keep Wal-Mart away from the city. That of course hurts poor and lower-income people the most.

http://www.chicagobusiness.com/cgi-bin/news.pl?id=19286&seenIt=1

Posted by: Chester White | Jan 9, 2008 10:30:32 AM

Agree with cinefoz. Start leaning against the wind. Some very good companies are starting to look like good values. Interesting technicals also. Just a thought.

Posted by: Ross | Jan 9, 2008 10:37:38 AM

Just after the rooster crows, the sun comes up. Obviously, the rooster causes the sun to come up, no?

The simple notion that correlation is not causation is a truth lost to much of science these days--in everything from positing that increased CO2 levels cause the earth's climate to grow warmer, to medical studies attempting to show causative correlations between various foods and cancer.

Good science is humble science that sees a correlation and attempts to ascertain a causal relationship. The WSJ is just speculating.

Posted by: Don | Jan 9, 2008 10:42:35 AM

Most political economists who forecast U.S. presidential elections use quarterly changes in the GDP, and the rate of unemployment (or the rate of new job creation) as the explanatory variable of the election outcome. The other explanatory variable is a peace/war/national security variable. See For example Michael Lewis-Beck and Charles Tien at Hunter College CUNY. Economics impacts political outcomes.

If the U.S. does go into a recession or at least stagnation, obviously GDP growth and job growth in the second quarter 08 will be negative for the incumbent Republicans. The political variable peace/war factor is highly negative for the Republicans. With virtually any candidate, the Dems will win the White House.

And frankly, it's a good thing. The ruling party has let things go to pot economically, and it's time for a reform/clean up effort.

Posted by: JohnR | Jan 9, 2008 10:45:52 AM

Change, we want change, the front runners offer no such thing.

"Change" has already occurred, after years of being whittled away, under Bush1, the Clinton's finally put the death knell in Glass-Steagal with Gramm-Leach, from Glass transparency to Leach parasitic. Now speeches are about how 2 terms of republicans have created the worst mortgage disaster in US history when every thing is going right according to the CFR schedule, as the new round is sanctioned contestants are considered for the next leader board. Hysterical!

Posted by: Stormrunner | Jan 9, 2008 10:50:01 AM

Stephen Moore, "McCain Clinton rally" said it again.

and says that with the same disingenuous, Shill smile oil traders have when they talk about the horrible international events affecting oil.

Posted by: Eric Davis | Jan 9, 2008 11:27:12 AM

Barron's, Business Week, Fortune, and others have all documented that both the national economy and the stock markets perform better during Democratic administrations than Republican administrations, but Wall Street never lets the facts get in the way of their blind support of Republicans.
.

Posted by: VJ | Jan 9, 2008 11:30:59 AM

That story about the Walmart needs some background - it is going into an area that is hardly representative of the economy as a whole. It is in a run-down, poverty-riddled, ungentrified area of dekalb county. Here's a link to the walmart location on Zillow - check out the property values to the south and west.

http://tinyurl.com/ys9cc5

This is inside the perimeter in traffic-plagued ATL, folks. When property values are low in a convenient location like this, it's the ghetto, the inner city. So 7500 people showing up for minimum wage jobs does not surprise me. If anything, it tells me that, contra to the conventional wisdom, the poor and downtrodden are looking for work, not lazy welfare freeloaders.

Posted by: Rusty | Jan 9, 2008 11:41:31 AM

"Cause & Effect". I think that we would all agree that greed not Obama are the cause of the current housing crisis & credit crunch. The effects of both are being felt by the U.S. now & eventually will be felt overseas as well.

I was watching Kudlow last night and he had some Clinton supporter on there talking about how she was more presidential than Obama. His reasoning went something like; because she had the opportunity to see alot of proposals (bills) that Bill had to make decisions on before he signed them and that he would ask for her opinon before making a decision. If that's the case then she was aware that he repealed the Glass-Steagall Act II in 1999 which was enacted in 1933 to prevent another depression by separating commercial and investment banking.

Allowing banks to realign in addition to Greenspan's 1@ FED rate cut run has led us to where we now find ourselves eight years later. I then argue that the Clintons are more responsible for our current economical situation than is Obama potentially being elected President.

Posted by: Pat Gorup | Jan 9, 2008 1:29:14 PM

Rusty said " it is going into an area that is hardly representative of the economy as a whole. "

Are you familiar with the Atlanta economy? We have fewer tech jobs now than in 2000.

Of the 40,000 jobs to be created this year, 12% are "Premium" jobs. That means they pay over $40,000. So an economy with 5.5 million people creates 6000 jobs that pay 40 grand.
Is that even enough to absorb the graduates of Georgia Tech, Georgia State, UGA, plus KSU and SPSU?

I think it totally represents the economy, and the economy sucks here.

Cherokee County is asking the state where their cut of the sales tax revenue is. It ain't there. Surprise.

It is more significant that 7500 people apply at Wal-Mart when the economy is supposedly booming. That is hardly anyone's dream job and yet they line up to apply.

You need to take a drive outside the perimeter and see that no longer do we have Lucent, World Com, many AT&T facilities, Bellsouth, Compaq, Sprint, HP, Nortel. those jobs are long gone.

Posted by: me | Jan 9, 2008 2:11:19 PM

December 2008

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