Confusing Politics With Economics

When indices are vulnerable -- during mutual fund outflows, fading M2 supply or excessive bullishness -- I notice everything else but those factors getting blamed for selloffs. Instead, we're asked to pick our poison: profit-taking, earnings news, Alan Greenspan, economic releases, geopolitics, terrorism, etc.

I have yet to find someone who can explain to me why some terrorist attacks roil the market, while others -- with the same appalling body count -- get shaken off. The horror of the situation is no less; the tragic waste of life no different. Yet the markets somehow have totally different responses to the same stimuli. So perhaps these headline events are not really causing the market to shudder and shake?

The latest causative error, blaming politics for the market's malaise, is akin to blaming the rooster for the sunrise. Equity markets haven't been skittish because the incumbent is in trouble. Rather, incumbents find themselves in re-election trouble when the market's future discounting mechanism incorporates a slowing economy into its pricing.

The market may not get it precisely right all the time, but it gets it right often enough to warrant paying close attention to what it's saying and why. If the economy slows, this gets reflected in the markets as lowered equity prices, often before the economic releases confirm it. Investors become less willing to pay more for slower growth, and that means weaker job growth. Invariably, this negatively impacts an incumbent's re-election chances.

A Look at History

Ned Davis Research did a recent study on post-World War II presidential campaigns and determined that while "job growth does not guarantee a victory, sluggish job growth historically has hurt the incumbent party." According to the study's data, the party in power lost the presidency whenever the change in nonfarm payrolls during the president's term was below 5%. This isn't a Republican or Democratic issue, but rather an incumbent vs. a challenger issue.

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Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].