Can the November Market Predict the Election?

 |  Includes: DIA, QQQ, SPY
by: Yankee Group

By Carl Howe

Today, the Wall Street Journal is officially calling the recent stock market downturn a correction. If the market loses another 10%, it will officially be a bear market. The story blames the credit crunch, Abu Dhabi's bailout of Citibank (NYSE:C), and SIV writedowns as the major causes, but I'd guess they'd add pestilence, famine, and a plague of locusts if they could garner enough fear, uncertainty, and doubt to convince the Fed to cut interest rates again.

Personally, I think this hand-wringing is overdone. Why? Because many years have a sell-off of stocks about this time. Mutual funds are readjusting their portfolios for end of the year reporting and distributions, investors are selling losing positions to offset profits before the end of the year, and consumers are trying to make sure they have enough money to cover their Christmas shopping lists. November is a great time for portfolio adjustments.

But there's another factor at work here: politics. Markets hate uncertainty of any type, and next year is a Presidential election year. If we look at the history of the Standard and Poor's 500 stock index, commonly known as the S&P 500, for Novembers before election years, an interesting pattern pops out:

Date S&P 500 month open S&P 500 month close Percent change Party elected president
11/1983 163.55 166.40 1.74% Same President Republican
11/1987 251.75 230.30 -8.51% Same party, different Republican President
11/1991 392.46 375.22 -4.39% Change in president and party to Democrat
11/1995 581.50 605.37 4.10% Same President Democrat
11/1999 1362.93 1388.91 1.91% Split decision
11/2003 1050.71 1058.20 0.71% Same President Republican
11/2007 1545.79 1407.22 -8.96% Change in president and party?
Click to enlarge

When the political winds forecast a change in political party and president, the stock market tends to sell off in the prior November. When a president is likely to be re-elected, the stock market tends to rise in the November preceding the election.

Now astute readers will notice a couple exceptions here, which involve both Bush administrations. Prior to the election of George Herbert Walker Bush in 1988, the stock market sold off in November 1987 by 8.5%. I would argue that this was a symptom of the stock market not liking the uncertainty involved in the replacement of two-term incumbent President, Ronald Reagan. While George H. W. Bush was of the same party, the market still considered him to be a risky choice, and therefore, the market sold off.

So what about 1999? In that case, I would argue that the market was forecasting the election of a same party Democratic president, and therefore did not sell off. And in fact, Democrat Al Gore won the popular vote -- only the Electoral College system and decisions by the US Supreme Court put George W. Bush in the White House. Clearly the November stock market effect couldn't predict that outcome, so I've marked that prediction a split decision.

That leaves us with November 2007. The market has sold off 9% this month, and the Wall Street Journal may be accurate in claiming that the market is undergoing a correction. But given the last 25 years of stock market history, I would argue that this isn't a correction; it's a prediction. And it's one that indicates we're going to see a Democrat in the White House next year -- we just don't know which Democrat it will be.