Economists Weigh In on Markets and Election

Pundits? Who needs them? If you’re wondering who will be taking the oath of office for the presidency next January, economists say you can get a pretty good idea, not by following the politics so much as by following the markets. Not to mention that you can also sort of predict market behavior by what is going on in politics. Sound confusing? Read on.

David Kelly (left), chief market strategist for J.P. Morgan Funds, pointed out that the election this November will be about much more than which party ends up occupying the Oval Office. In a statement, he said it "will likely determine the pace of deficit reduction over the next few years with implications for both economic growth, in general, and the Treasury market in particular." He added, "In addition, who gets elected president will likely impact the mix of tax increases and spending cuts employed to achieve this deficit reduction."

But that’s not all. Watching politics in the coming week, he said, could give investors a good idea of what might be in store for markets, as well, since the outcome of the Iowa caucuses and early primaries could indicate which way the wind might blow for Republicans.

Kelly said, "A drawn-out fight on the Republican side might require the candidates to placate the more extreme elements of the party, whereas an early putative nominee could put some pressure on Republican members to compromise in a year where the public has little patience left for intransigence." He continued, "This is particularly important given the 60-day deadline to come up with a year-long extension of the payroll tax cut and extended unemployment benefits."

While Kelly expected the first few indicators of 2012 to be positive–anticipating modest gains, he said, for both the ISM Manufacturing Index and the Non-Manufacturing Index, with light vehicle sales also showing a general up trend, the big numbers to watch are the unemployment figures and the jobs report. The former could fall back after last week’s numbers, which were higher than expected. The latter is expected to show solid gains, based on demand, confidence and labor market indicators.

Still, if unemployment numbers are revised upward after last month’s surprising drop, and should last month’s numbers also be revised upward, that could tell a different story. And, of course, there are China and the eurozone crisis to consider–both weighing in on our economy as well.

So is the dog wagging the tail or the tail wagging the dog? Sam Stovall, chief equity strategist

at S&P Capital IQ, said that if 2012 turns out to be a normal presidential election year, the S&P will record gains in seven out of 12 months, and in all four quarters, but with substandard quarterly and full-year rises. The first 10 months of the year would reflect unsettled markets as investors stress over the election results, and then markets would post gains for the last two months once things have been decided.

But January could be the decider of how things will go for the rest of the year. Said Stovall in a statement, "If there’s one thing presidential election years are good at, however, it’s predictability. The January Barometer was correct eight of eight times in forecasting positive calendar-year performances, while the frequency with which the S&P 500 has risen during the presidential election year has been comforting at 75%. In addition, the market has been successful more than 85% of the time in predicting whether the party in power will remain in power or be replaced." If it goes up, it might mean good news for Obama.

He concluded, "Therefore, whatever the S&P 500 doesn’t provide in absolute return this year, it will likely make up for in predictability."