• Thu
  • Aug 21, 2014
  • Updated: 9:08am

Polls apart from the truth

PUBLISHED : Monday, 05 March, 2012, 12:00am
UPDATED : Monday, 05 March, 2012, 12:00am

This year seems to be the year of big and small elections. There are presidential elections in France, Russia and the United States, and even here, in Hong Kong, we have something resembling an election for the chief executive. This outbreak of elections provides a good opportunity for all sorts of nonsense to be aired about the correlation between elections and investment performance. The hard facts of the matter remain elusive, but there are a number of pointers that could be useful to investors.

What generally happens around election time is that market pundits are rounded up to give their views on which candidate or party would be best for markets and to explain how investment sentiment might help to swing the election. Despite alleged supporting evidence, most of what they say can be discounted.

Let's start with a recent piece of research from the US-based InvestTech group, which produced a number of headlines proclaiming that the stock market picks 90 per cent of presidential elections. The researchers claim that the stock market has been the 'most reliable indicator' of who will win the US presidency for the past 100 years. They found a correlation between strong markets and good consumer sentiment and elections in which the incumbent wins, while market volatility means that he will lose.

Here is a classic confusion of cause and effect. Come election time, the incumbent will naturally strive to stimulate the economy and create confidence. This is not some kind of random event; it is a deliberate political act carried out, without exception, by all incumbent office holders, including US president Franklin Roosevelt during the depths of the 1930s Depression.

What matters is not whether these measures actually work, but whether they are perceived as being capable of working. So the markets are not supplying omniscience, only reflecting how the system works.

Stock markets, as everyone knows, are the classic barometer of perceptions. They move on the basis of anticipation, not history, and they do not necessarily reflect reality. So, the fact that rising markets help incumbent presidents get re-elected merely indicates that the incumbent has persuaded the public that his policies will work. It is not the case that markets have somehow independently created favourable conditions for the election of an incumbent president.

Secondly, pundits like to talk about which parties are best for the markets. This is particularly so in the US, where Republicans are said to be better for capital markets than Democrats. However, research by academics James Grant and Emery Trahan, published in 2006, found that equity markets tended to fare better when Democrats were in the White House and bond markets tended to flourish with Republicans.

At one time, there was a popular theory developed by markets commentator Yale Hirsch - the presidential election cycle theory - that markets are weakest in the year following presidential elections but improve after the first year. The evidence since the mid-20th century has been mixed, but some patterns seem to hold for the current period.

First, in presidential election years (not just in the US), markets tend to be stronger than in other years. Second, a study of the Standard & Poor's 500 Index by Professor Marshall Nickles, covering 1942-2003, shows that buying stocks on October 1 in the second year of a presidential term and selling them at the end of an administration's fourth year is a good strategy that has worked for about 60 years.

What market pundits like to tell us is that markets crave government stability. This claim, incidentally, is made for chief executive candidate Henry Tang Ying-yen, who is having trouble finding other positives for his campaign. However, it is plain nonsense. Markets like a bit of instability, as they move on the basis of change. Active traders want as much change as possible because it provides market fluctuations and thus great trading opportunities.

So should investors be paying attention to all the noise generated by elections? Basically, no. As the old anarchists used to say, elections don't change much because the government always wins. But it is also true that when markets rise and the economy booms, incumbent politicians will claim credit, but when things start to turn bearish, they will shake their heads and decry the fecklessness of market forces.

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