Elections and Equity Prices

The 4.1% gain of the S&P 500 on November 4, 2008 has been attributed as an election-related rally. Economic reality took over on November 5 with the S&P 500 falling 5.3%. Readers have asked about the short-run presidential election impact on equity prices, if any. One way of looking at the relationship between equity prices and presidential elections is by comparing the status of the economy and the change in equity prices in the months between election and inauguration days. The Misery Index (sum of unemployment rate and year-to-year change in the Consumer Price Index) is a handy indicator of the status of the economy. Comparing the change in the Misery Index with the change in S&P 500 will suggest if election euphoria played a role or if underlying fundamental conditions of the economy prevailed. Table 1 lists the change in the Misery Index between January and September of an election year and the change in S&P 500 on last trading of January vs. the trading day of October prior to day of election.

If presidential election results played a role in equity prices in the short-run then equity prices should rally in the short period between election and inauguration days, reflecting the euphoria of the election. On the other hand, if economic fundamentals dictate equity prices, then there should no be no impact on equity prices. A rough approximation, without detailed regression analysis, would be that if the Misery Index was advancing in the months prior to presidential elections, reflecting the status of the economy, then equity prices should post a decline in the short period. However, if economic fundamentals are irrelevant in the short-run, equity prices would show a gain in the short period between election and inauguration days.

Data listed in table 1 indicate strongly that equity price changes are related to the performance of the economy with election results having no role to play. During 1948-2004, an increase in the Misery Index between January and September of election year is associated with declines in S&P 500 between the last trading day after inauguration and last trading day of October prior to election. There were five exceptions (shaded gray in table 1) in the 15 presidential elections after the war; each one has a convincing reason for atypical behavior rooted in economic fundamentals. In 1948, the Misery Index was 13.6% in January and dropped to 10.3% by September. The U.S. economy was in a recession from November 1948 to October 1949. The unemployment rate advanced from 3.4% in January to 3.8% in September, but inflation was heading down after war-related events had driven up inflation. The drop in the S&P 500 was indicative of an impending recession. The second exception was after the 1960 election; the recession ended in February 1961. Inflation and unemployment rate are lagging indicators that were advancing but equity prices rose, implying the end of a recession. The third exception was in 1976 when the Misery Index fell and stock prices declined. The economy was recovering from the 1973-75 recessions, one of the longest post-war recessions. The fourth exception was in 1992, when both the Misery Index and S&P 500 posted gains. The 1990-91 recession was a short recession which was coined as a jobless recovery. Employment conditions did not improve for an extended period, which accounts for the increase in the Misery Index. The fifth and last exception was in 2004, when the Misery Index rose slightly reflecting higher inflation as the economy grew, while stock prices mirrored the boom in the housing market.

Labor Market Conditions Continue to Deteriorate

Initial jobless claims fell 4,000 to 481,000 during the week ended November 1. Continuing claims, which lag initial by one week, rose 122,000 to 3.843 million, the highest since February 1983 (see chart 2). The insured unemployment rate rose to 2.9% from 2.8%, the highest in nearly five years. In addition to jobless claims data, the ISM employment indexes, the Conference Board’s labor market indicators, which are part of the survey for Consumer Confidence Index, and the ADP employment data are sending a unified message of significantly weak labor market conditions, implying the probability of very weak payroll numbers and unemployment rate for October, which is scheduled for publication on November 7. Our forecast is a 175,000 drop in payroll numbers and a 6.3% unemployment rate.

Bank of England Takes Bold Step to Ward Off Severe Recession

The Bank of England’s Monetary Policy Committee (MPC) acted decisively this morning, cutting the Bank Rate 150bps to 3.00% – its lowest level in over fifty years and the largest rate cut since the Bank gained full policy independence in 1997.

The MPC statement noted the "very marked deterioration in the outlook for economic activity at home and abroad" and the fact that the risks to inflation "have shifted decisively to the downside," leading to a "substantial risk" that headline CPI would undershoot the 2.0% target in the medium-term. The Committee pulled no punches, describing the sharp fall in output in the UK in the third quarter, the recent tightening in money and credit conditions as a result of the serious disruption in the global banking system, and business surveys and reports that point to "continued severe contraction in the near term."

The economic data have certainly been unremittingly gloomy in recent weeks. Today came the Halifax house price report for October, which revealed that prices fell 2.2% on the month (the ninth successive decline) and 14.9% on the year – the steepest fall since the series began in 1983. Halifax calculates that prices have now fallen 15.7% from their peak, which means that many thousands of homeowners probably are already in negative equity (where the mortgage exceeds the value of their home).

The financial services sector has played a key role in underpinning the UK’s strong and steady economic growth in recent years. Reading between the lines, the MPC is concerned that the financial sector’s woes, combined with a global demand slump, risk pushing the UK into a severe recession. We doubt that today’s rate cut is the last. There may be an indication of the

Committee’s policy outlook in the minutes of today’s meeting, which will be released November 19. The BoE’s Inflation Report, to be published November 12, will include the Bank’s latest forecasts for output and inflation.

ECB Cuts Again But Accelerating Slowdown Points to Further Easing in December

As expected, the European Central Bank (ECB) lowered its refi rate again today, taking it down 50bps to 3.25%. In his subsequent press conference, Governor Trichet stated that the Council discussed cutting by 75bps but was unanimous in its decision to lower by 50bps. Unlike in the UK (see above), the minutes of this discussion will never be released, but it appears that the Governing Council missed a chance to move more aggressively.

Earlier this week the European Commission released its latest economic forecasts, anticipating real GDP growth of just 0.1% for the 15-member Euro-zone next year, and 0.2% for the 27-member EU. Q3 GDP data are due November 14, but the Commission stated that the Euro-zone is already in a technical recession. Assuming that the Q3 data are as weak as expected, and given the extent to which forward-looking data are deteriorating, the ECB is likely to ease again at the December 4 policy meeting.

One indication of the severity of the looming downturn across the Euro-zone is the state of German manufacturing orders. Today came the news that September’s orders posted their biggest monthly fall since 1990, plunging a seasonally-adjusted 8.0% on the month, led by an 11.4% drop in foreign orders.

Swiss National Bank Opts For Intra-meeting Rate Cut

The Swiss National Bank (SNB) announced an intra-meeting rate cut today, lowering its target band for three-month Swiss franc LIBOR to 1.50-2.50%, down from 2.00-3.00% previously, and aiming for the mid-point – effectively, a 50bps rate cut to 2.00%.

Although Swiss inflation eased by less than expected in October – the headline rate came in at an annual 2.6%, down from 2.9% in September – there are plenty of other signs for a more marked decline in inflation and that the economy is headed for recession going into 2009. The SNB stated today that the global economic outlook "has deteriorated more severely than anticipated" and warned that in Switzerland "growth in 2009 might even be negative."

Earlier this week the SVME Purchasing Managers’ Index showed that Swiss manufacturing contracted for the second consecutive month in October. The PMI fell to 47.0, down from 47.8 in September and its lowest since mid-2003. The last time the PMI remained below 50.0 for two consecutive months was back in the summer of 2003, when the economy was struggling out of a prolonged period of weak-to-negative growth. That was also the last year the Swiss economy posted a full-year contraction.

Last week the KOF Economic Institute released its latest leading indicator, which points to the economy’s likely performance in six months’ time. The October indicator dropped to 0.35 from 0.52 in September, its lowest level since July 2003.

With Switzerland’s major export markets slowing sharply the economy is set to fall into recession around the turn of the year, and could be in for more than two consecutive quarters of negative real GDP growth. If current trends continue, the SNB is likely to ease again at its next scheduled policy meeting on December 11.