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Can Markets Predict Presidential Elections?

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Low volatility this summer may be an indication that stocks markets are beginning to price in a win for Hillary Clinton in November, according to Burt White of LPL.

The chief investment officer of LPL Financial wrote in a weekly commentary note that election years have historically been good for markets, with the greatest levels of volatility coming in the middle and late summer months prior to an election. Volatility subsides as markets learn more about candidates and begin pricing in a winner, he wrote.

The “relative calm” in the markets over the past few months “may partly reflect that the market is increasingly pricing in greater certainty that would come with a Hillary Clinton victory, as her support has climbed in the polls.”

The election and Clinton’s prospects in it are only part of the reduced volatility story. White noted that improving economic conditions have clearly “played a key role” in the rising stock market over the past six months. Furthermore, it’s not clear what either candidate could get through Congress, he wrote, or who will have the majority in either the House or the Senate next year.

“We can speculate that recent stock market gains partly reflect greater certainty under a Clinton administration. But polls can be wrong (case in point: Brexit),” White wrote. “It’s possible that the market’s strength has little to do with the election. So perhaps a better question to ask is: Do strong stock markets predict elections?”

Since 1928, 82% of elections have been correctly predicted by an increase (which predicts a win for the incumbent) or a decrease (predicting the challenger will prevail) in the stock market over the three months prior to the election, according to White.

There are some notable divergences from that theory. In 1932, when the market was up 15.4% in the August through October period, the race went to the challenger, Franklin D. Roosevelt. In 1956, Dwight D. Eisenhower won despite the markets being down 7.7%. Twelve years later, the election went to Richard Nixon, with a 5.8% increase in the market. In 1980, Ronald Reagan won following a 4.8% increase in the market in the three-month pre-election period.

White added that for elections following a two-term president, an increase or decrease has correctly predicted the election going to the incumbent or challenging party 100% of the time, “but granted, this covers a limited number of occurrences,” including Roosevelt’s election to his third and fourth terms.  

A closer look at more “politically sensitive industries” yields a less certain win for Clinton, White wrote. “If the market was pricing in a Clinton victory, certain industries where her platform may not be as supportive would be expected to lag the market (and vice versa).”

In the financial sector, Clinton is expected to be tougher than Donald Trump. She supported the Dodd-Frank Act, and has indicated a willingness to break up “too big to fail” banks and charge a risk fee on others, White wrote.

From mid-May through July, the odds of Clinton winning tracked the inverse relative performance of banks and capital markets stocks, according to White. “But during the last couple of weeks, as Clinton’s odds of winning increased in the polls, financial stocks did well. Gains in these stocks in August likely reflected the move in interest rates, from 1.46% on the 10-year Treasury at the end of July to just shy of 1.60% late last week, which may have overwhelmed politics,” he wrote.

The alignment between polls and market performance in the health care sector is mixed. Clinton’s support of the Affordable Care Act, which should lead to more insured patients and better profitability for health care facilities and managed care groups, hasn’t borne out in performance. “Some of this inconsistency, we believe, reflects the profitability challenges for certain healthcare institutions under the ACA,” White wrote, particularly pharmaceutical stocks, which may reflect doubts that “even in a Democratic administration, it is unlikely that major drug reforms will get through Congress.”

As Clinton’s odds improved earlier this summer, oil and gas exploration and production stocks underperformed, and energy stock’s outperformance this month was driven by expectations for an OPEC agreement, White wrote.

Finally, construction materials stocks increased with solidifying plans from Trump to spend twice as much on infrastructure, according to White.

— Read Morning or Midnight in America? 9 Questions for the Presidential Candidates on ThinkAdvisor. 


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