Yesterday, fellow Fool Morgan Housel came out with a brilliant piece on the correlation between the unemployment rate and the chances an incumbent (or his party) will be re-elected.
You would think that if a president has lowered unemployment rates, the chances for re-election would be high, and vice versa. Alas, Morgan cites evidence from statistician Nate Silver -- who culled evidence from as far back as 1912 -- to conclude: "There's virtually no correlation between the unemployment rate on Election Day and an incumbent's chance of winning."
Morgan is able to point out one possible reason for the weak correlation: "The average voter in the last two elections ... has not been representative of the broader economy. They've been in much better financial shape than the average American." In other words, unemployed people are less likely to head to the polls; their wealthier counterparts are far more likely to make their voices heard.
Knowing this, I think there's an even better and more accurate way to find a link between re-election and the economy: the behavior of the Dow Jones Industrial Average (INDEX: ^DJI ) . Take a look, and you'll see that as far back as the election of 1900, the movement of the index between Sept. 1 and Election Day has successfully predicted the winner almost 90% of the time, with gains working in favor of the incumbent party and losses favoring the challenger. (Years in which the opposite occurred are italicized.)
DJI Change from Sept. 1 to Election Day
Did Market Predict Winner?
Source: Analyzeindices.com; Google Finance.
One could easily argue that in 1968, the withdrawal of President Johnson, assassination of Robert Kennedy, and ensuing mayhem at the Democratic National Convention in Chicago could explain away at least one instance where the market didn't predict the winner.
One could also argue that in 2004, a shrewd move by Karl Rove to put same-sex marriage amendments on the ballots of swing states -- thereby driving social conservatives disproportionately to the poll -- could offer up an explanation for the second aberration.
But whether or not certain instances can be explained away, one thing is clear: There is a high correlation between the movement of the markets immediately preceding an election and the chances that the incumbent party will win.
Going back to Morgan's point -- that the voting population is usually skewed toward those with employment and higher incomes -- this makes sense. The market is a forward-looking tool: A rise represents optimism, and a fall, pessimism.
While this might not tell us who has the upper hand right now, it lets us know that both President Obama and Mitt Romney will be on the clock starting in three months, and the movements in the market will likely let us know who will be sitting in the Oval Office come January 2013.
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