U.S. Economy And The November Election: The Importance Of Being The Incumbent

Includes: ITA, SPY, XLE, XLU, XLV
by: Eric Parnell, CFA

The upcoming presidential election in November promises to rank among the most important for the U.S. economy in years. The outcome will have a meaningful influence on the future business and regulatory environment for a variety of industries including the energy (NYSEARCA:XLE), defense (NYSEARCA:ITA), health care (NYSEARCA:XLV) and utilities (NYSEARCA:XLU) sectors. It will also greatly impact what we can expect from future tax policy, the profile of the Supreme Court and, perhaps most importantly, determining who will be directing monetary policy as Chairman of the U.S. Federal Reserve. And with the U.S. economy careening toward a fiscal cliff at the end of 2012, the outcome of the election will likely have a profound and immediate impact both on the economy and the stock market (NYSEARCA:SPY).

Given the major importance the election results are likely to have on the economy over the next four years, it is worthwhile to begin assessing the probabilities associated with the election outcome today. I will look to accomplish this objective through a variety of lenses in a series of articles over the coming months leading up to November.

Before going any further, the purpose of this article as well as future installments is not to promote or refute any particular political party or ideology. Instead, it is simply designed to apply data analysis in an impartial way in order to help draw conclusions about what we might expect in the coming months. After all, our primary objective as investors is to set aside biases and anticipate future outcomes to position accordingly in advance.

Historically, one of the most critical factors in determining the outcome of U.S. presidential elections has been incumbency. This includes the following characteristics:

* An elected president that is currently in office and running for another term

* An elected vice president that was then sworn into the presidency due to the passing of a president during his term.

In either of these cases, this incumbency status has resulted in a high probability of winning the election. And of course, President Obama qualifies under the first of these incumbency characteristics listed above.

A look back over the history of presidential elections reveals the significance of incumbency on presidential election results. The United States has held 56 presidential elections dating back to when George Washington won his first term. In 26 of these 56 elections, an elected president was running for re-election. In four additional instances – Theodore Roosevelt in 1904, Calvin Coolidge in 1924, Harry S. Truman in 1948 and Lyndon Johnson in 1964 - a president that had been elected as vice president but ascended to the office during his term was running for re-election.

In 21 of these past 30 instances, or 70%, the incumbent won the election and another term in office. This fact alone bodes well for President Obama. But given that the upcoming 57th presidential election is occurring under what might be described as less than typical economic and market conditions, it is worthwhile to examine the 9 remaining instances where the incumbent did not win.

The following is the list of incumbent candidates that did not win re-election.

John Adams - 1800

John Quincy Adams - 1828

Martin Van Buren - 1840

Grover Cleveland - 1888

Benjamin Harrison - 1892

William Howard Taft - 1912

Herbert Hoover - 1932

Jimmy Carter - 1980

George H.W. Bush - 1992

So what is notable, if anything, about these past nine elections where the incumbent lost?

Two that immediately jump out are the elections of 1888 and 1892. In 1888, Grover Cleveland won the popular vote but lost the electoral vote to Benjamin Harrison. But in 1892, Cleveland won a rematch against Harrison, with the results impacted by the presence of third party Populist candidate James Weaver, who earned nearly 9% of the vote and carried four states out of 43 at the time.

Several other elections were meaningfully influenced by the presence of third party candidates. In addition to 1892, a third party candidate played a notable role in the 1912, 1980 and 1992 elections. In 1912, Theodore Roosevelt became the last third party candidate to finish second in the popular vote. In 1980, moderate John Anderson registered roughly 7% of the vote. And in 1992, Ross Perot received 19% of the popular vote. Thus, three of the four presidential elections over the last century that saw the incumbent lose included a notable third party candidate.

This leaves us with only four U.S. presidential elections in history where an incumbent president was running in a two-candidate election and lost both the popular vote and the electoral vote. And three of those four past instances took place over a century and a half ago in the early to mid 1800s. But such are the conditions that are shaping up for the 2012 election.

Although all of these factors bode well for President Obama, the list above has one remaining stand out exception over the last century. That, of course, is the election of 1932 when Franklin Roosevelt defeated then incumbent President Herbert Hoover. A particularly notable point about that election was that it occurred during a period of financial crisis and meaningful economic stress in this country. And the margin of victory for President Roosevelt was also significant at 57% versus Hoover at just 39%. This suggests that if economic conditions are sufficiently challenging, the advantage of being an incumbent can quickly become a major liability.

Revisiting the election of 1980 is worthwhile in this same context. Even if President Carter received all of John Anderson's votes, which would have been unlikely given that Representative Anderson had run as a moderate in the Republican primaries that year, he still would have lost to President Reagan by three percentage points in the popular vote. And once again, Reagan's victory came during a period of great economic stress with inflationary pressures running rampant in the economy at the time.

Bottom Line

History shows that President Obama enjoys a tremendous statistical advantage in running for re-election as an incumbent. But history also shows that if economic conditions increasingly deteriorate in the coming months, his status as an incumbent may quickly turn to a liability and begin to favor presumptive Republican candidate Mitt Romney instead.

So just as the winner of the November election is likely to have a profound impact on the economy over the next four years, the economy is likely to have a profound impact on which candidate wins in November. This will make the economic data all the more important to watch in the coming months. It should be very interesting to see.

Disclosure: I am long XLE, XLU.

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.