In this weekends Barron’s, Michael Santoli asks this question:

“Is it possible that an Obama victory wouldn’t, in itself, be unfriendly to market returns? Re-election of an incumbent is rarely jarring for financial markets and usually requires an improving domestic economy. And second presidential terms are about legacies, rather than heavy-handed policy-making. It’s fair to say that this idea is outside the mainstream of Wall Street thinking.”

This is one of those comments that lead to misinterpretation, logic errors and deductive flaws. Santoli understands the issue, but its so easily misinterpreted by investors. Let’s briefly deconstruct this paragraph, and explain why it may be misinterpreted:

1) Misplaced Credit: As we have stated repeatedly over the past few election cycles, Presidential market blame & credit is greatly exaggerated. The bottom line is that the US chief executive gets more credit for good markets, economies and business cycles, and more blame for when they are poor than is remotely reasonable or fair. This is true regardless of party, economy, cycle, etc.

2) The Obama Bull Market: If you don’t buy into my arguments about the gross credit/blame exaggeration, than why are you concerned about any incumbent victory? The S&P closed at 850 the day before Obama was sworn in; yesterday’s close was 1,280.70 — a 51% gain over three years. If you buy into the foolishness that President’s drive markets, than given his giant market gains,  Obama is your guy.

3) Understanding Causation and Correlation: The error that the politicos often make is anthropomorphizing markets. You can see this in their language: Markets “prefer” one candidate over another, as indicated by short term rallies and sell offs. They show markets rising and falling with a candidates polling as proof of this. In the process, they make the classic correlation error, failing to recognize the same forces are driving both sets of numbers.

The effect of economy being either good or improving significantly is that it impacts profits. When earnings are expanding, they support higher stock valuations. Hence, the same underlying factor typically leads to both rising stock prices and improving incumbent polling.

Market participants should learn to understand Causation, and recognize when a false correlation pops up. They also need to put the day-to-day noise into the larger context of quarters and years. Doing so will help them become better investors.

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Previously:
Presidential Blame & Credit (November 22nd, 2011)

The Market Magic of Democrats vs GOP Presidents (December 3rd, 2011)

Source:
Thought Experiments
Michael Santoli
Barron’s January 7, 2012
http://online.barrons.com/article/SB50001424052748704330804577138672645756272.html

Category: Markets, Philosophy, Politics

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

10 Responses to “Context, Causation, Correlation”

  1. [...] Context, Causation, Correlation.  And knowing the difference.  (TBP) [...]

  2. Wexler says:

    “Most practitioners before the modern scientific era, and most purveyors of pseudoscience today, rambunctiously mix their metaphors, crisscross the connections, and get seduced by surface similarity.”

    - Pinker, “The Stuff of Thought”

  3. rktbrkr says:

    Stock markets have generally performed better during Democratic admins than during Repub admins and my Repub friends astutely attribute this to “luck”, ditto Clinton’s balanced budget. The real estate meltdown during Bush the Lesser’s second term was due to Clinton for the CRA and FDR for creating Fannie & Freddie and Bush was unable to stop the carnage in spite of Repub majorities for 6 of his 8 years. You gotta think Orwellian to understand the economics of it all.

  4. Mark Down says:

    And some Presidents drive the market into a ditch! 2001 s&p 1360 7 1/2 years later s&p 1317

  5. capitalistic says:

    There’s no direct correlation between a US president and the markets – I agree.
    However, there’s a correlation between the president (and politics) of a developing country, and US sentiment of that president.

  6. AHodge says:

    If santoli means, once the election is over,
    and the airwaves are not polluted with two sides making everyone feel anxious and bad
    the markets may do better, i agree, even if the winner is a D
    this is how i have traded the election cycle for over two decades
    that honeymoon
    with even the other side saying its not so bad
    does not last more than 4 months
    otherwise fade all politics
    having a daily show segment called money polititcs is pure kudlow propaganda
    in the past the only other politics i traded was capital gains news.

    but now is different–not only do we have third world desperate economic measures specifically said to target stock market–but an entire class of economic illiterates
    this gives new meaning to the cynical hope for divided govt

    i think an R sweep and “unified” Rs say Gingrich or santorum
    and house and senate
    not just the tea party rank n file but the likely R committee heads
    Jerry lewis, Lethician, Ryan the whole menangerie.. ought to make an investor right nervous

  7. deanscamaro says:

    All of this has nothing to do with reality. It is politicians using events to portray their party in the best light; so they select an event and try to make it their own or use it to blame the other party. It is nothing but wrangling for votes.

  8. notakid says:

    It is nothing but diving for dollars! FTFY.

    It is amusing to say the least to see the lengths the hacksters on either side will go to in the my guy was an economic genius debate.

  9. [...] Investors confuse causation and correlation all the time.  (Big Picture) [...]

  10. AHodge says:

    the post election “honeymoon” is of course more heartfelt when there is a new pres.
    vs someone wih 4 years of reality for the electorate to chew on