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Compass Financial - Weekly Market Commentary August 11 2008
Compass Financial - Weekly Market Commentary August 11 2008
By the start of March, John McCain had clinched the Republican nomination,
Jeffrey Kleintop, CFA
and since then the economy has been the number one issue for investors
Chief Market Strategist
LPL Financial and voters, so maybe it is no surprise to see the relatively tight relationship
between the performance of the stock market and McCain’s odds of winning
the 2008 presidential election. [chart 1]
Highlights
History suggests it is not surprising to see Will the markets dictate the winner of the election?
the relatively tight relationship between
the performance of the stock market and
Historically, there is little predictability in the outcome of a presidential elec-
McCain’s odds of winning the 2008 presidential
tion based on stock market performance during the incumbent party’s term
election since McCain clinched the Republican
in office. Franklin D. Roosevelt was re-elected in a landslide victory in 1940
nomination.
despite huge losses in the S&P 500 during his term. Harry Truman and Rich-
ard Nixon also were re-elected in the face of lackluster stock market results.
The stock market has predicted the winner of Moreover, vigorous performance in the markets does not guarantee elec-
the presidential election fairly accurately. For tion for the incumbent party. Adlai Stevenson lost even though the market
example, over the past 80 years, during 11 of the rose 75% in 1949-52 under his party’s administration, George H. W. Bush
12 times the incumbent party was reelected the lost in 1992 even with a 57% gain in the stock market during his tenure,
S&P 500 had posted a gain during the 90 days and despite the nearly 80% gain in the S&P 500 in the four years from 1997
prior to Election Day. through 2000, incumbent party candidate Al Gore was unable to hold onto
the White House in 2000. However, during the 90 days leading up to Election
A negative outlook by investors has tended to
Day the stock market has predicted the winner fairly accurately.
favor political change and a win by challengers,
while market gains may indicate that the Over the past 20 presidential elections, during 11 of the 12 times the
macroeconomic environment is on the right track, incumbent party was reelected, the S&P 500 had posted a gain during
which has benefited incumbents. the 90 days prior to Election Day.
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W E E KLY MARKE T COMME N TAR Y
1 McCain’s Presidential Prospects Track the the stock market has been more likely to respond to whether the incumbent
Stock Market political party won or lost. Reflecting back on the year after an election over
Price of Intrade contract “John McCain to win 2008 US the past 80 years, the stock market’s reaction has had three distinct periods.
Presidential Election”
During the turbulent period of the 1920s, 30s, and early 40s that
Intrade Odds of McCain Win S&P 500
45% 1475 included the stock market crash of 1929, the Great Depression, and
43%
1425 World War II, the stock market favored challengers over incumbents.
41%
39% 1375 From the mid-1940s until the early 1970s the stock market reaction to
37% 1325 the election outcome was mixed—neither favoring nor fretting over
35%
33%
1275 incumbents.
31% 1225
Over the past three decades, noted for above-average stock market
29%
1175
27% returns and lengthy economic expansions, investors appear to have
25% 1125
displayed a strong preference for incumbents
Feb-29 Mar-29 Apr-29 May-29 Jun-29 Jul-29
Source: Intrade, Bloomberg, LPL Financial
STOCK MARKET ELECTION REACTION HAS HAD THREE DIFFERENT PERIODS
Bold Lines Represent Years When Incumbent Lost
U.S. Treasury Zero Coupon Bonds (STRIPS)
S&P Price
Market Performance Performance Year
Average Return Election Year After Election Incumbent Party Winning Party
Year after Favored 1928 -11.9 R R
Challengers 1932 46.6 R D
Challenger = 46.6% 1936 -38.6 D D
Incumbents= -22.8% 1940 -17.9 D D
1944 30.7 D D
1948 10.3 D D
1952 -6.6 D R
Mixed
1956 -14.3 R R
Challenger = 1.7%
1960 23.1 R D
Incumbents= 3.7%
1964 9.1 D D
1968 -11.4 D R
1972 -17.4 R R
1976 -11.5 R D
1980 -9.7 D R
Year after 1984 26.3 R R
Favored Incumbents 1988 27.3 R R
Challenger = -6.8% 1992 7.1 R D
Incumbents= 18.9% 1996 31.0 D D
2000 -13.0 D R
2004 3.0 R R
? 2008 ? R ?
Source: Bloomberg, LPL Financial
This result is intuitive, since another term for the same party is likely to
result in a more consistent geopolitical, legislative, and regulatory environ-
ment than a shift in the balance of power to a new administration, raising the
level of uncertainty. The uncertainty can be seen, when incumbents lose, in
greater risk aversion for both corporate leaders in pursuit of earnings growth
and investors in the form of valuations. S&P 500 earnings-per-share growth
has been positive on average during the first year of an incumbent’s term,
but negative when an incumbent loses. Likewise, price-to-earnings multiples
have typically expanded during the first year of an incumbent’s term and
contracted when the incumbent loses.
In the bond market, the political party of the winner of the election, rather
than whether the incumbent or challenger was elected, has historically af-
fected performance. Since the late 1920s, during the year after a presidential
election the bond market has fared better under a Republican president, with
government bond returns of 6.8%, than a Democrat, 4.3%, as measured by
the Ibbotson Intermediate Term Government Bond Index.
While market performance is likely to have some measurable influence on
the election outcome, and likewise, the political environment has some influ-
ence on market performance, the relationship is by no means assuredly pre-
dictive. We believe the stock market will post a fourth quarter rally, typical of
an election year. While that rally could already be underway, we continue to
believe that more volatility is likely over the remainder of the summer, leav-
ing the influence on the election in doubt. The potential fourth quarter rally
may not transpire until after Election Day, as it did in 1992 and 2004.
IMPORTANT DISCLOSURES
This report has been prepared by LPL Financial from sources believed to be reliable but no guarantee can be
made as to its accuracy or completeness. The opinions expressed herein are for general information only, are
subject to change without notice, and are not intended to provide specific advice or recommendations for any
individuals. Please contact your advisor with any questions regarding this report.
Investing in international and emerging markets may entail additional risks such as currency fluctuation and
political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially
less liquidity.
Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
Indices are unmanaged and cannot be invested into directly.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest
rate rise and are subject to availability and change in price.
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