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Woodard: Politics and Market Noise

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As I mentioned on Tuesday, one of the stories traders have been telling each other is that the rally in coal stocks since last week's first Presidential debate had to do with Governor Romney's positive comments about coal and with the bounce that Romney saw in the polls after the debate. Similarly, a stall in the price of Health Care SPDR ETF (XLV) is supposed to reflect lower odds that the Affordable Care Act will remain current law in a Romney administration, which would be a worse outcome for health care providers (never minding the lack of clarity about the legislative politics involved in such a repeal). If you look at the daily changes in the Romney contract on Intrade along with prices of Market Vectors-Coal ETF (KOL) and XLV, however, the story falls apart.

fig. 1. Romney.2012.Pres, KOL, and XLV Daily Closing Prices, Sep - Oct 2012
Source: Intrade, Yahoo!, Condor Options


Since the debate on October 3rd, KOL has gained 5%, which is well within the realm of statistical noise given the ETF's tendency over the last year to move in double-digit percentage swings over any given two-week period. XLV is lower by 0.5% over the same period, which is actually better than the S&P 500 (SPY) return of -0.6%.

A broader theme for many conservative-leaning investment strategists is that the market would prefer to see a Republican administration because of presumed lower taxes, lax regulation, and so on. This is a perennial talking point during every election cycle; respondents dutifully pull out annotated charts showing that, over the last several decades, stocks have actually fared better under Democratic presidents. Of course, the whole discussion is of little value, since the policies of any one administration are likely to have effects on the economy and the market, whether good or bad, that may not be felt for years.

fig. 2. 1M Rolling Correlation Among KOL, XLV, and Romney.2012.Pres to SPY Returns, 2012
Source: Intrade, Yahoo!, Condor Options


Additionally, we can drill down on what the market actually thinks about this election by checking the correlation of stock returns to the political winds as tracked on Intrade prediction markets. Since the beginning of 2012, the correlation coefficient of changes in Governor Romney's Intrade percentage and the change in the S&P 500 has been 0.054. Let's be maximally generous to the finders of spurious meanings and plot the rolling correlation of Romney's electoral chances and other relevant relationships to the market - we're doing this in case a full-year correlation estimate obscures some periods in which the relationship was especially strong. Looking at this plot (fig. 2), it becomes even clearer how little swings in the election data have to do with equity returns. There has been a steady rise in the monthly correlation of KOL to the market since early September, but this was mostly reversion toward the mean level for the year and likely is better explained by changes in the natural gas market.

We hardly think of coal as a straightforward proxy for the equity market, and yet even the coal ETF has managed a one-month market correlation in the range of 0.50 - 0.80 for most of the year, while the Romney contract flip-flops above and below the zero line.

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