Elections and Economy

by Karen Gibbs - Wall $treet Week with Fortune

Friday, October 29, 2004

Some characterize this presidential election as the most important election ever, but that's been said about many campaigns in years past. A New York Times editorial dated July 2, 1888, said of the Harrison vs. Cleveland presidential race, "The Republic is approaching what is to be one of the most important elections in its history." President Gerald Ford said during a 1976 debate with Jimmy Carter, "I think this election is one of the most vital in the history of America." Ronald Reagan described his 1984 race against Walter Mondale as "the most important election in this nation in 50 years."

So it should come as no surprise that this presidential race is billed as "the most important election ever." But this campaign is not just about a quest for power, it's also about the economy. According to USA Today research, the "blue chips," also known as the Dow Jones Industrial Average have posted positive returns in 8 of the past 10 presidential election years.

The economy is one influence in how voters choose a president. In tough economic times, voters often look to a new leader, and when the economy is strong, voters often stick with the status quo. But how does the market react to our choices?

We have historical data showing that markets do well during elections. In the event an incumbent loses, we tend to see a post-race rally, as people adapt to and rationalize the change. When an incumbent wins, it suggests the economy is pretty good and the markets then have a fundamental reason for rallying. In any case, people are either happy with the direction of the country or the economy or they're looking forward to a change.

Wall Street is said to be a Republican bastion and therefore should perform better under a GOP administration because it is assumed to favor business interests. But the fact is, according to the Stock Trader's Almanac, the stock market performs better under Democrats than it does under Republicans. Using data from the start of the 20th century up until 1995, stocks gained an average of 10.5 percent when Democrats were in the White House versus an 8.1 percent average yearly gain under a Republican administration.

But that's only half the story. Inflation tends to be higher under the Democrats and lower under Republicans. So the better stock market performance under the Democrats is often offset by a reduction in the purchasing power of the dollar.

Ideally, markets prefer gridlock - a divided government. The best stock markets of the past three decades have been under Presidents Reagan and Clinton - chief executives who faced congressional majorities from opposing parties. Gridlock works because it forces both sides to the middle. Pragmatic moderation is an effective economic policy. Hardcore ideological approaches tend to be disastrous.

It all boils down to one simple phrase, "It's the economy, stupid," as James Carville so aptly put it.

Voters often choose with their pocketbooks. It's no surprise then that both parties pull out all stops to get the economy in the best possible shape before the election. According to pundits, today's combination of fiscal (government spending) and monetary policy (low interest rates) is the most dramatic policy in recent history. It's good for the nation's output and the economy, and therefore the stock market. But it's the post election economic reaction that will be more important to the stock market. Unfulfilled campaign promises and curbs on government spending have meant a spottier performance for the markets in postelection years. In fact, stocks have risen only half of the time in the years following elections since 1941.

So what's the stock market telling us? The overriding message is that it hates uncertainty. The economy has slowed down since the start of the year, thanks in part to soaring oil prices. Businesses have reacted by hiring fewer people than expected and giving smaller raises and bonuses. When workers, both consumers and investors, feel less secure about their jobs and their financial future, they become less optimistic and less likely to buy goods, services and equities. The Dow and the Nasdaq are down for the year. The S&P is virtually flat on the year. That situation usually bodes poorly for the incumbent because voters generally assign credit or blame to the president for the economy's success or failure. The fact is that presidents have little impact, if any, on the economy (although one could argue that this president has had more impact than most with tax cuts). Most of the time, the Federal Reserve chairman is the most powerful man in terms of influence on the economy as he and his merry band of men and women set short-term interest rates that affect everything from variable credit card rates, to auto loans, to mortgage rates.

What makes this such a difficult election to forecast is that we have no similar period of time with which to compare. We have never seen a presidential term with a burst market bubble, a major recession and subsequent jobless recovery, a major terrorist attack on U.S. soil, big tax cuts and three wars (Afghanistan, Iraq and the war on terrorism).

What to do Nov. 3? First, don't panic. Investing should be done with a long-term time horizon and your risk tolerance in mind. Once the dust settles, the stock market will once again focus on profits and earnings, the driving force behind capitalism.

Karen Gibbs brings more than two decades of business and financial experience to PBS's "Wall Street Week with Fortune" in both market and journalism arenas. She is a frequent keynote speaker for business and financial conferences and events nationwide. Prior to joining "Wall $treet Week with FORTUNE," Gibbs was at the forefront of television business coverage as a senior business correspondent for Fox News Channel, contributing coverage to and serving as substitute anchor on "Your World with Neil Cavuto" and appearing as a regular panelist on "Cavuto on Business." As an anchor at CNBC, Gibbs specialized in credit and futures markets, and she hosted "Money Wheel" and "Minding Your Business."

Are economic considerations affecting your vote for president this year? Is the state of the stock market a primary indicator of economic health to you? What economic issues concern you most?

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