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It’s The Economy, Or Are We Stupid?

It’s The Economy, Or Are We Stupid?
28 Sep
9:33

By Jerry Wagner

Back in 1992, in the early days of a presidential election year, Bill Clinton’s campaign manager, James Carville, famously wrote on the campaign’s office whiteboard, “The economy, stupid!” He was reminding the campaign staff that the economy, then deep in a recession, was the primary issue in voters’ minds and ought to be the campaign’s focus as well.

The phrase subsequently morphed into “It’s the economy, stupid,” and it restates the old political chestnut that voters vote with their pocketbook. If the economy is doing well, they vote with the incumbent party. But if the economy is struggling, the out-of-power party should have the advantage.

The power of the economy to influence elections has been demonstrated in other ways too. One study has shown that the level of unemployment is a good predictor of presidential elections. If unemployment is rising at election time, incumbents struggle, and vice versa.

The stock market is a good harbinger of the economy. It’s the single most important component in the Index of Leading Indicators. It tends to lead the direction of the economy by about six months on average.

There is a largely unheralded indicator of presidential elections. It successfully predicted the winning presidential candidate in every election except three since 1945 (an 83% correct record). It posited that if in an election year the stock market was lower on November 1 than it was on July 31, the candidate of the party not controlling the White House would win. As it turned out in 2016, stocks were lower for the period and that candidate was Donald Trump.

The impact of a good or bad economy on elections should be obvious. Most people have to make ends meet. If the economy is doing well, they are most likely to be employed. Consumer confidence should be running high and retail sales should be soaring, providing momentum for even more growth and good times to come. Understandably, the party that was in control during such fortuitous times tends to benefit from this.

Yet this year a very different outcome is being predicted by the pundits.

All of the measures of a healthy economy are in place. In fact, the numbers suggest that it is one of the best economies of modern history (since WWII). Unemployment is at historic lows, interest rates and inflation are still low, economic measures are near highs, and consumer and business confidence have been soaring.

But the measures of the generic vote (“Who do you favor in your congressional election, the Republican or the Democrat?”) for the midterms has been favoring the Democrats. According to a recent article in The Economist, this is probably the best of many indicators of congressional vote outcomes. Their midterm election indicator is forecasting a 71% chance of Democrats taking control of the House in 2019.

Will voters this year prove Mr. Carville’s axiom wrong? Are they irrational or even, as James Carville suggested, “stupid” to be ignoring the economic realities? Or perhaps, it’s just a matter of “this time it’s different.”

I can make a case that this time is different. I’ll leave the alternative rationale to others.

It is true that the stock market and the economy have been positive for a long time. This uptrend extends back to 2009, predating the current administration by many years. Many Republicans will counter that it wasn’t much of a recovery, leaving President Obama with the only administration in history to fail to achieve 3% economic growth.

But the economy started from a very deep hole in President Obama’s first year, and it did get better until near the end when it seemed to be stalling out. Of course, that stalling out and the 2016 weakness in stocks may have contributed to the change in power in 2016. But the fact is that the market and economy have been rising for a very long time and that improvement did span two different party administrations. The case to some then may not be that clear-cut as to which party to attribute today’s great economy. As a result, this time may be different.

Another reason it may be different is the incredible partisanship and animus displayed by the electorate. Each side seems to hate the other. There has been no middle ground acceptable to either. And the very reality perceived by each side is completely different. Where one side sees prosperity and progress, the other side can only see the failings of its opponents.

Of course, in such an environment, the independents control the outcome, but their voting behavior is the most volatile. By their nature, they swing back and forth in their support of the parties. With both the Congress and the president, despite the healthy economy, viewed unfavorably by a majority, this time may indeed be different.

Finally, both the president and the Democrats have sought to nationalize the midterms. Where once the midterms were the province of local office holders and local issues, this year both parties have sought to impose top-down themes upon the election. Add to that the tendency of the party in power to lose seats in the midterms and it makes the applicability of Mr. Carville’s advice seem less likely this time around.

Of course, we won’t know until we actually have the election whether the state of the economy will be ignored and whether the currently predicted outcome will match what seems so obvious in the press today. After all, back at this time in 2016, it did seem inevitable that Mrs. Clinton would be our president today, instead of Donald Trump.

Market update

Just as the electorate seems poised to ignore the healthy economy, the stock market last week demonstrated its independence from the negativity that seemed to be overwhelming the news from many sources. The Senate and the Supreme Court confirmation process seemed to be mired in quicksand that could leave the Supreme Court in a deadlock when it reconvenes the first Monday of October.

China and the United States traded accusations over trade, then threats of more tariffs leading to China’s exit from the negotiation and the U.S. creating an expanded list of tariff-subject goods.

Despite all of the background noise, the Dow Jones Industrial Average set its first new high since January. The S&P 500 gained ground for the eighth of its last 11 days. Market breadth expanded to new all-time heights, as did the breadth of all market sectors, except Utilities.

If you take a longer-term view of the stock market, you have to be very pleased and, I believe, are right to expect even more positive days ahead. It is a near-perfect environment for stocks.

In the short term, however, investors could be taking one step backward after their two steps forward. The market moved into overbought territory last week (it has moved up too far, too fast). Every time that has occurred this year, stocks have turned lower in the short run.

In addition, this week is historically the worst week of the year. The last week of September has seen lower prices on average since 1929. In fact, our friends at Quantifiable Edges have charted out an investment in the S&P restricted to just investing this week since 1961. I don’t think anyone but a short seller could fall in love with this chart:

Money continues to flow to bond mutual funds and ETFs instead of the stock market variety. This is perhaps because short-term T-bill yields have exceeded the S&P 500 dividend yield for the first time since the mid-2000s. While many see this as a negative for stocks, history demonstrates that this is actually the normal state of the relationship.

Note: The dark blue line represents the three-month T-bill yield. The red line represents the S&P 500 dividend yield.

Bonds have been falling all year, it seems, and they sure tumbled again last week. I continue to believe the flow to bonds to be a mistake – that if we take a longer-term view of the stock market than just this week, it actually looks like the place to be for the remainder of the year.

Volatility has fallen to levels last seen in the 2017 bull market year. Sentiment is very moderate, not at the extreme levels that normally presage a bear market.

Most bear markets occur during recessions. Of the many recession indicators that I review, none are predicting a recession within the next year.

Finally, there will probably be much talk on the financial shows about the Federal Reserve meeting this week. It is expected that the Fed will once again raise rates.

Some commentators will view this as a negative for stocks. However, as we have pointed out in the past when interest rates and inflation are low, Fed rate-tightening is just another indication of a prosperous economy. Stocks, like voters, tend to thrive in such an environment. A quick look at the following chart confirms this fact, as each of the rising rate environments shown was accompanied by a rising stock market as well.

The background noise may be disheartening, the bombast of politics and trade upsetting, but stocks are likely to be the place to be for the remainder of 2018. After all, as the man said, “It’s the economy…”

Source: https://seekingalpha.com/article/4208618-economy-stupid

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