Uncertain Indicators

DECISION 2020

By Andrew Prochnow

An abyss of uncertainty— that’s what the upcoming presidential election represents for the country and the financial markets. To see why the election results are shrouded in mystery, let’s examine the results of three different predictive approaches.

First, an economics-based model indicates a Joe Biden win, while a markets-based approach predicts a Donald Trump victory. Second, a history professor famous for choosing the winners of presidential races has called the contest for Biden, while a well-known political scientist says his model favors a Trump landslide in the Electoral College. Third, traders in the prediction markets are betting on Biden.

If Biden wins, as most polls predict, the “wall of worry” on Wall Street will turn upside down.

For example, the “Green New Deal” championed by former Vice President Biden would reverse the current administration’s policy objective of “energy independence.” President Trump touted the revival of the coal industry during his 2016 campaign and has maintained the nation’s dependence on fossil fuels.

But change wouldn’t be limited to the energy sector—not by a long shot.

If the Democrats win a majority in the Senate, hold onto their majority in the House and Biden captures the White House, they would likely overturn the comprehensive tax reform package the Trump administration pushed through in 2017.

Another huge unknown relates to China and the trade war—a conflict that has arguably morphed into something much broader during the last six months.

With so much at stake, investors are seeking insight into the potential fallout of the election. While nothing is known with 100% certainty, history teaches that the formation of certain patterns leading up to a presidential election has successfully predicted the outcome.

Two indicators that have foretold the results of presidential elections include:

• The performance of the stock market during the three months immediately preceding the vote.

• The performance of the economy leading up to the election. Specifically, is the country currently in a recession—yes or no?

The history of the stock market is significantly shorter than the history of presidential elections, with reliable trading data extending back only as far as roughly 1928. In comparison, the first U.S. presidential election was held in 1788.

Limiting the analysis to data from 1928 forward, historical patterns reveal that if the stock market rises during the three months immediately preceding a presidential election, the incumbent party wins 87% of the time.

Since 1928, there were only three exceptions to that trend: 1956, 1968 and 1980. That means over the course of the last nine elections (going back to 1984), that predictive trend has been accurate 100% of the time.

But the stock market isn’t the only indicator that’s successfully predicted the outcome of many presidential elections. The performance of the U.S. economy has also foretold the outcome.

With the economy, it’s pass or fail. Presidents aren’t likely to win re-election if a recession occurs during their first term.

Since 1900, four of the five presidents who ran for re-election during an economic downturn lost—which is 80%.

The unlikely winner was William McKinley in the year 1900. Unfortunately, McKinley’s luck soon changed when he was assassinated at the start of his second term in 1901.

The four presidents who ran unsuccessfully for re-election amid a recession were William Taft in 1912, Herbert Hoover in 1932, Jimmy Carter in 1980 and George H.W. Bush in 1992.

The United States officially entered a recession in February of 2020, according to the National Bureau of Economic Research’s Business Cycle Dating Committee. That means Donald Trump will be the sixth president since 1900 to attempt a re-election bid while at the helm of an underperforming economy.

If the election were held today, these trends and data suggest two different winners—President Trump, according to the stock market, and former Vice President Biden, according to the economy. But the discrepancies don’t end there.

A couple of well-known experts with a knack for predicting presidential elections have also announced conflicting prognostications.

In late August, historian Allan Lichtman indicated Joe Biden would win come November. By some measures, his presidential predictions have been accurate 100% of the time going back to the 1984 election—including in 2016. The model does not rely on polls, but instead uses the country’s economic status, social unrest, military success and scandals.

Long before Lichtman’s prediction went public, political scientist Helmut Norpoth announced the results of his prediction model, which also disregards polling data and instead focuses on the results of presidential primaries. He’s successfully predicted five of the last six presidential elections. But when it was applied to the last 27 presidential elections (after the fact), it was correct 25 times. In 2020, Norpoth’s model indicates that President Trump will win re-election.

The betting markets—websites such as PredictIt and Smarkets—also gauge political sentiment. At press time, the PredictIt market showed Biden with a sizable lead over the incumbent.

Biden’s candidacy gained momentum back in June when the former vice president surged past President Trump for the first time. Currently, the betting market favors Biden to a greater degree than historical trends (the stock market, the economy) and the opinions of experts (Lichtman and Norpoth)— with the latter two split more evenly down the middle.

Those contradictory findings could mean the country is in for a highly competitive race for votes from a passionate electorate. And that passion will more than likely spill over into the financial markets.

Market volatility tends to rise during presidential election years. And in 2008, when a presidential election occurred during a deep recession, market volatility went parabolic. This year, the election seems even more uncertain than usual as chaos reigns among the usually reliable predictors.

Andrew Prochnow, an avid, longtime options trader, has written extensively on professional tennis and contributed articles to Bleacher Report and Yahoo! Sports.