The GOP Presidential Race And Stock Market Psychology

Includes: DIA, QQQ, SPY
by: Eric Parnell, CFA

We clearly are living in an act-now-ask-questions-later world right now.

One of the most notable characteristics of the stock market over the second half of 2011 has been the violent swings both up and down. For a while, stocks will cascade violently lower as if the financial world is coming to an end. Then suddenly and often without reason, it will explode higher as if all is well with the world again. But these cycles of behavior are not confined to the stock market. Instead, it is just a part of the broader psychology of many people today. They are anxious, and they are exploring a variety of channels in trying to discover change and solutions.

One has to look no further than the competition for the Republican nomination for President of the United States to see this psychology. The race has been well underway now for much of the second half of the year, and what we have seen is similar cycles of behavior among the electorate. And just as the stock market has shown the propensity to eagerly rally on the hopes of decisive action against the problems overhanging the global economy, many Republican voters are eagerly searching for a candidate that stirs up their hopes for taking decisive action in Washington. And just as the stock market has cycled in recent months, so too have the front running candidates cycled in the Republican field.

Highlighting this point is an examination of the polling data from the GOP Presidential race since the summer. The field has been defined by two separate categories of candidates. The first are those that have experienced very consistent support at various levels. These include Mitt Romney, Ron Paul, Rick Santorum and Jon Huntsman. The second category, which is the more notable of the two, includes those that have experienced dramatically sharp spikes in support suddenly whipped up by enthusiasm that they might be the candidate to incite the change for which these Republican voters are hoping. These include Michele Bachmann, Rick Perry, Herman Cain and Newt Gingrich.

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Focusing on the second group, the chart above shows the aggregate polling data over time from Real Clear Politics for each of the four candidates both leading up to and following their peak in the polls. In each instance, the candidate began experiencing a sudden surge that lasted roughly 45 days. And with the exception of Gingrich who is now at roughly 45 days but has yet to peak, each of the other candidates saw their polling numbers return toward prior levels over the following 60 days.

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What is particularly notable is that the sudden rise of each successive candidate coincides almost exactly with the peak of the previous candidate (see chart above). In other words, Bachmann’s peak in the polls coincided almost exactly with the beginning of Perry’s surge, and Perry’s peak in the polls coincided almost exactly with the beginning of Cain’s surge, etc.

This GOP voter behavior is a microcosm of the general psychology of many people today. And it is holding true when supporting candidates from any political party, when managing their investment portfolios or when generally living their daily lives. Many seem anxious about their current circumstances and are eagerly looking for answers and solutions. But in many cases, they are so eager to find these answers that they are acting first and asking questions only later. In the case of the GOP field, they have acted swiftly to enthusiastically throw their support behind four separate candidates since July. And in three of these instances, it appears that voters came to find out only later than the person they swiftly supported did not turn out to be exactly what they were looking for upon closer examination. And in each of these three past instances, they moved on to the next potential candidate they believed would incite the change they were craving. In this latest cycle, the onus is now on Mr. Gingrich to see if he can break the trend of his three predecessors and keep the momentum going.

This same behavior is playing out in the stock market. Investors appear eager to see action taken to resolve the problems overhanging the market. They are clearly anxious about the global economy and the stock market outlook, which induces them to sell the market off violently when it seems that no solution exists for problems like the European debt crisis.

But just as quickly, stock investor hopes will suddenly rise on the idea that an answer can be found. Typically this notion centers on some extraordinary policy action from European leaders, the European Central Bank or the Federal Reserve. Even if nothing has occurred to actually support such notions, investors will drive the market higher if for no other reason than the belief that policy makers will have to blink with aggressive action before letting the global financial system go back over a cliff. With this newly-found confidence, stocks go off and running for a spell with the hope that this time around we’ll finally soon see the answers to the market’s problems.

But only after taking a closer examination of the situation, typically following a disappointing summit or policy meeting, investors suddenly realize that the real solutions they have been hoping remain frustratingly elusive. And the cycle begins anew. Looking back on the stock market over recent months, these shifts between optimistic “hope” phases and pessimistic “reality” phases have lasted about a month on average.

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All of this highlights a key point. The stock market has been volatile and unpredictable in recent months. But this capricious behavior is not limited to just stock investors. Instead, it is part of the psychology driving many people in their general decision making. After several challenging years following the outbreak of the financial crisis in 2008, many are anxious to take action and are eager to see the solutions they believe are necessary to be actually applied. But this fervor for change and action is causing many to act first and ask questions later, which is leading to disappointing realizations once things turn out to not be as they so hopefully believed.

Thus, as long as the global economy remains in flux and people feel restlessly eager to take action and enact change, we are likely to see this volatility continue for investment markets. Until we see a final resolution in Europe (either good or bad) or some truly bold initiatives by policy makers (such as major ECB bond purchases or QE3 from the Fed), markets are likely to continue their manic behavior in swinging between “hope” and “reality”.

Applying this thinking to the current market, these “hope” and “reality” cycles have been lasting almost precisely 19 trading days. More specifically, the first “hope” cycle was 17 trading days, the second “reality” cycle was 22 trading days, and the remaining three cycles were all 19 trading days each. Just like the polling trends with the GOP candidates, this has become a predictable pattern within a narrowly defined range. And since the bottom on November 25, the most recent “hope” phase is currently running 10 trading days and counting. If the recent pattern continues to hold, this would imply the current market peaking around December 22 before a new “reality” phase begins. Such timing would also provide the market with its typical December rally and would also align precisely with the typical duration of stock market rallies before they fully roll back over following major weekly gains like we experienced the week after Thanksgiving.

It will be interesting to see how events play out both for the stock market and the GOP race in the coming days and weeks leading up to the New Year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.