Stocks: Can the Market Predict a President?

The S&P 500's record in the three months before the Presidential election can often predict the next party in the White House. Should John McCain and Barack Obama be keeping a close eye on the stock market?

Recently, a friend told me that the price performance of the Standard & Poor's 500-stock index during the three calendar months leading up to the U.S. Presidential election was a good predictor of whether the President or his party would be re-elected or replaced. Basically, the idea is that a positive performance by the index signals a positive result for the incumbent or the party in power; a negative performance by the "500" means the opposite.

Intrigued, I decided to perform my own back test. I found this election-prognostication technique did an excellent job, recording a 79% accuracy rate in predicting the re-election of the party in power and an 83% success ratio in calling for a change of party.

There have been 20 Presidential elections since 1928; 2008 will mark the 21st. Based on the S&P 500's performance in the three-month period of August through October, this indicator correctly predicted re-election or replacement 80% of the time.

Digging a little bit deeper, I found the index's performance also did an excellent job of forecasting if the existing person or party would be re-elected. In these 14 occurrences, the model was correct 11 times, or 79% of the time. It was wrong in 1932, since the S&P 500 gained more than 14%, yet President Herbert Hoover was still voted out of office. Maybe investors were encouraged that Franklin D. Roosevelt would be elected and anticipated that "happy days would be here again."

The market was also wrong in 1968 when the market's action predicted that Hubert Humphrey would be the first vice-president elected to the Presidency since Martin Van Buren. Of course, third-party candidate George Wallace stole enough Democratic votes to make Richard Nixon pleased as punch.

Finally, in 1980 the model took one for the Gipper, as it pointed to a Jimmy Carter re-election only to defer to "voodoo economics" and the Reagan Revolution.

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