SPX and 2012 Elections

With the 2012 elections looming, politics are increasingly dominating newsflow. And it is only going to get worse, news will be all politics all the time by summer. Speculators and investors will be watching with great interest, as these elections' outcome will impact the markets for years. But provocatively, the fortunes of the stock markets will heavily influence voters' psychology and therefore the results.

Sentiment, or how people feel about the state of things, is incredibly powerful. We all experience it every day of our own lives. When things are going well, we tend to see everything through rose-tinted glasses. Right after you get a nice raise, a flat tire isn't too distressing. But when we are faring poorly, everything feels more ominous and wearying. That same flat tire when you are battling adversity could be crushing.

While it is private triumphs and struggles in our own little lives that generate most of our personal sentiment, broad macro factors also play a sizable role. There are events that shape collective psychology, sentiment on a national level. Remember how terrible we all felt after the 9/11 terrorist attacks? Even news that doesn't directly touch our lives can really alter our psychological states.

But it is not just one-off events that can deeply impact our collective psyche. There are also factors that heavily influence how we all feel on an ongoing basis. And chief among them is the state of the US stock markets. When the markets are strong, we all feel better about everything. The sky is bluer and the grass is greener. And when the markets are weak, a nagging aggregate sense of pessimism emerges.

This is perfectly logical for speculators and investors, as the fortunes of the stock markets greatly affect our wealth. You will feel a heck of a lot different if your portfolio is down 20% rather than up 20%. The former will lead to general pessimism that pervadesall aspects of your life, while the latter will spark similarly-far-reaching optimism. Everyone with capital in the markets has experienced this in spades.

But unfortunately the majority of Americans are not investors. The key prerequisite to investing is to first spend less than you earn, to live below your means long enough to build up surplus capital. Many people lack the discipline to live leaner, and thus never save enough to meaningfully invest. And many others struggle with incomes so low that saving is an impossible burden that would leave them hungry.

Yet provocatively, even this majority without a stake in the financial markets is heavily influenced by their fortunes. Sometimes I marvel at this. Why should people without any investments even care if the markets are up or down? But after a quarter century of trading and studying the markets, it is ever-more apparent to me that they do. Even if they don't realize it, the stock markets greatly color their sentiment.

The clearest example of this is the most-extreme market event of our lifetimes, 2008's once-in-a-century stock panic. In a single month, the flagship S&P 500 stock index (SPX) plummeted an epic 30.0%! Think about that a second. In a matter of weeks, nearly a third of the entire wealth invested in the US stock markets simply vaporized! And that was a major fraction of our nation's wealth as a whole, a disaster.

While the investors and speculators with capital deployed understandably felt devastated, so did everyone else. The plummeting stock markets led to a crippling widespread belief that a full-blown depression was approaching. Fear, anxiety, and pessimism soared everywhere, even in people who didn't lose a dollar in the panic. Our collective psychology was absolutely rotten, mired in deep worry.

This shock to our psyche almost certainly radically altered the outcome of the 2008 elections. We went to the voting booths just one week after October 2008's initial stock-panic lows, when fear remained viscerally overpowering. Even though the SPX had bounced 18.5% higher in this short span leading into Election Day, it was still 17.1% lower than 5 weeks earlier. Scared, worried, anxious voters always tend to kick out the incumbents!

Barack Obama had run on the amorphous concept of "change", and inspired many Americans with his hopeful rhetoric. Yet he was an underdog on many fronts, young and inexperienced. But the sheer psychological shock of the stock panic allowed him to eke out a narrow victory over John McCain, winning 52.9% of the popular vote. Countless independents gave Obama a shot because they were scared about the stock markets and economy.

Interestingly, the fragile markets weren't too excited about Obama's victory given his campaign promises of massive tax hikes on investors and crushing regulations on the companies we own. The SPX plunged 5.3% the day after Obama's win, ultimately free-falling another 25.2% lower over the next couple weeks or so. But it was extreme economic anxiety, mostly fueled by the stock panic, that slaughtered the incumbents.

And as the stock markets inevitably recovered out of that extreme fear maelstrom, Obama's job-approval rating in the polls was closely correlated with the SPX. Elite polling firms like Gallup run fascinating daily polls. It is remarkable just how closely Obama's fortunes match the stock markets' own! During major stock uplegs Obama's job-approval rating rises, and during major corrections it falls. Check out Gallup's 3-day rolling-average Obama job-approval and job-disapproval ratings superimposed over the SPX.

When the stock markets are strong near highs after major uplegs, Obama's job-approval rating is high and his job-disapproval rating is low. This was most pronounced last spring, after a major SPX upleg topped. But when the stock markets are weak near lows after major corrections, this flips. Far more Americans disapprove of how he is handling things compared to those who approve, like last autumn.

Why is this? Why is our entire nation's collective sentiment so heavily influenced by the state of the stock markets when the majority of Americans aren't investors? I've pondered this a great deal over the years, and have some ideas. I suspect the biggest factor is the media, with economists shouldering much of its responsibility. Personal relationships also likely play a major role in the stock markets' influence.

Most of the people who work in the mainstream and financial media are not poor, they have indirect stock-market investments through their retirement plans. So like all investors, they feel better when the stock markets are thriving and worse when they are languishing. This market-driven psychology creates an unavoidable selection bias in the stories they choose to cover and how they report on them.

Compounding this is economists, who are naturally the primary source of interviews and commentary on news stories about the economy. Economists are notorious for their weathervane-like reactions to stock-market swings. They are wildly optimistic after the stock markets have enjoyed a big rally, and dismally morose after a major selloff. So their own sentiment heavily colors the stories they are interviewed for.

Much economic data isn't inherently bullish or bearish. Economists must choose how to interpret individual data points. An unemployment rate of 8% is perceived differently by these dismal scientists depending on what the stock markets have been doing. After a big rise, it will probably be seen as bullish and heading lower. But after a big fall, this same number will likely be interpreted as bearish and trending higher.

If you want to dig deeper into news psychology and economists' sentiment, I've written past essays exploring both. But the end result is the news stories average Americans read or watch, in every medium, tend to be more optimistic when the markets are up and more pessimistic when the markets are down. While you certainly have experienced plenty of this, you can easily verify this phenomenon empirically.

Use the Web or a local library to look up past copies of major newspapers and news magazines from particular dates. The first is late April 2011, when the SPX was enjoying new bull-market highs after a major upleg. The great majority of the stories then were positive and optimistic. The second is late September 2011, when the SPX was plunging to scary correction lows. Most stories then were negative and pessimistic.

We are all heavily influenced by the media we consume, and the people who produce and contribute to those stories are heavily influenced by the state of the stock markets. Personal relationships also come into play. Even people who aren't investors know and usually work for people who are. So when they hear their friends or bosses frightened or excited about the markets, it often leads them to think similarly.

Small business has always been the engine of economic growth in America. And the entrepreneurs who start businesses and work hard enough usually achieve success. By the time they can hire other people to work for them, they have often generated plenty of surplus capital. They generally invest a major fraction of it in the stock markets. So as business owners talk with their employees, their sentimental state really rubs off.

And businessmen are greatly influenced by the state of the stock markets in a major indirect way as well. When stocks are up, everyone tends to spend more. And vice versa. Economists have long coined this "The Wealth Effect". When you aren't anxious or worried about your job, you are much more likely to buy things. But when you are scared, you tend to pull in the horns and save just in case your income falls.

This phenomenon seriously impacts the lifeblood of small business, revenues. Nothing is more important to small businessmen than sales! And when the stock markets are up so everyone feels better about everything, sales tend to boom. But when the stock markets are weak and people get scared, sales slump. So small-business sales, and hence owners' psychology, is deeply affected by the stock markets.

You can test this out yourself too. Most of us frequent some small businesses for goods or services, and it is easy to gradually get to know the owners or managers. Every few times you go in to buy something, ask them how sales are doing. Are they seeing the economy improving? After you establish baseline responses, ask the same questions when the stock markets are high or low. Almost without fail, they'll tell you business is slow after a major stock-market selloff.

And business owners are much more likely to shelve expansion plans when the stock markets have recently slid. So their employees not only realize the owners are worried, but they see long-time plans put on hold which makes them fear for their own jobs. The fortunes of the stock markets affect business in multiple major ways, and even the non-investor employees can't help but to assimilate the resulting market-driven sentiment.

So regardless of the exact mechanisms, even the majority of Americans who aren't directly invested in the stock markets have their sentiment heavily colored by the SPX's fortunes. When the markets are thriving they feel more secure in their jobs and expect to see raises over time. When the markets are bleeding, they get worried and anxious and extrapolate forward a bleaker future with less income.

One of the most famous political phrases in modern history was created by Bill Clinton's infamous campaign strategist James Carville. "It's the economy, stupid." This phrase was hammered relentlessly to help unseat George Bush the elder. We Americans really do vote our pocketbooks. If we feel our lot in life is improving under an Administration, we aren't likely to vote against it. But if times are tough, we don't hesitate to boot out the incumbents. New management brings new hope.

And the stock markets truly are the dominant driver of all economic psychology. While it is certainly true that unique situations in individuals' lives are stronger influences, on the national collective level nothing rivals the stock markets' broad impact. So just like the 2008 elections and the ones before that, the 2012 outcome will be majorly influenced by what the stock markets are doing in the months leading up to November 6th.

If we see a strong SPX rally in September and October, and the stock markets are near highs in early November, Barack Obama's odds of winning a second term will be much higher. But they are much lower if we see an autumn stock-market selloff batter the SPX near lows heading into the actual voting. As polarly divided as our country is politically these days, the prevailing fortunes of the stock markets will very likely decide the upcoming elections! All it takes is a few-percent swing among independent voters.

So what is likely to happen? A couple weeks ago I wrote an essay on the state of the SPX's current cyclical bull market and the latest upleg within it. For a variety of technical reasons on several time scales, today's rally is likely to persist until late spring at least. Summer is even a possibility, depending on how high the SPX gets relative to its secular-bear resistance of 1500 before that. Soon after 1500, we are due for either a major correction or possibly a new cyclical bear market.

If this upleg crests too early, so the correction is over by late summer and the SPX can rally into autumn, the Democrats have a better chance of winning. But if this upleg crests later, or the SPX lingers near highs during the summer before correcting like it did last year, the subsequent selloff (correction or new bear) should hit in autumn. And that would give the Republicans a much better chance of winning.

In pure market terms, politics aside, this second scenario looks more likely based on my research. The flagship S&P 500 only has to rally another 10% or so from here to hit its decade-old secular-bear resistance of 1500. And that would make for an easy and gradual ascent into late spring, no sharp surges sparking upleg-killing excessive greed, before the stock markets' usual May seasonal peak.

By mid-May this latest SPX upleg would be about 7.5 months old, and would have powered 37% higher in total if 1500 is indeed achieved. And the stock markets naturally tend to grind sideways in the summer anyway, when anxiety gradually builds for big selloffs that are most likely in autumn. Interestingly this year, politics and the stock markets will interact to gradually ramp anxiety heading into the next major selloff.

As we've clearly seen in the past several months, the higher the SPX travels the better Obama's polling numbers get. Due to the markets' dominant influence on national psychology, this will continue as long as the stock markets keep grinding higher on balance. So by the time today's upleg peaks in late spring or summer, the Republicans will look like they don't have a prayer of winning. Their discouragement will be rampant.

But the investors and businessmen dominating the stock markets are generally not Obama fans at all. We don't want his additional crushing punitive taxes on hard-working successful people who already shoulder the vast majority of this entire country's tax burden. And we don't want more inane regulations that strangle our businesses and force us to spend more and more time filling out paperwork for useless meddling bureaucracies.

So as higher stock markets lead to more general optimism, oddly the core investor crowd is going to get more pessimistic and worried as Obama's star rises in the polls. This will lead to discouragement and despair that will coalesce into selling and accelerate the correction or new bear market. And the resulting falling SPX will gradually taint America's psychology as a whole heading into the elections. The timing of any major SPX lows relative to Election Day will be exceedingly interesting to watch!

Almost all short-term stock-market price action is driven by traders' collective sentiment. So at Zeal we try to carefully consider everything that influences it, including politics. Then we do the opposite of what consensus thinks best, buying low when others are scared and selling high when others are greedy. Our prudent contrarian trading approach has proven wildly successful. Since 2001, all 598 stock trades recommended in our subscription newsletters have averaged stellar annualized realized gains of +48%!

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The bottom line is stock-market fortunes heavily influence politics and election outcomes. We all feel better after the markets have rallied to highs, and worse after they have sold off to lows. This influences our perceptions of the state of the economy and our own prospects, and we all vote with our pocketbooks. So rallying stock markets are good for incumbents, while falling ones often see them booted out.

Heading into the 2012 elections, this latest upleg and maybe even the entire post-panic cyclical bull are likely to top this spring or summer. This means a selloff is likely in the cards for late summer or autumn, and it could be either a major correction or the birth of a new cyclical bear. The weaker the stock markets look heading into October, the higher the odds we will elect a new President on November 6th.

Adam Hamilton, CPA

February 24, 2012

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