Confusing Cause & Effect: Elections and Markets

Its an election year, and that means sophistry and ignorance in equal measures will be flooding the airwaves and intertubes.

We have taken it as our charge here to fight against the logically challenged and the factually incorrect. We addressed this exact issue four years ago, but given the propensity us Humans have for self-delusion, we must crank up the wayback machine, and review some basic economic and logical truths.

The latest meme making the rounds — I’ve seen it in the WSJ, on Kudlow’s show and read it online — is a move to blame the recent market turmoil on the rise of Obama at InTrade, or to correlate the sell-off with the declining polls for the incumbent party.

The WSJ fell prey to this same reasoning:

“Worry about possible policy changes can weigh on markets ahead of a presidential vote. If an incumbent seems likely to win, markets often recover by the fall. This year, with many of the candidates on both sides promising change, the risk is that the market jitters could linger.”

Markets do not recover because the incumbent seems likely to win; rather, the underlying conditions that work to the advantage of markets — robust growth, brisk consumer spending, job creation, income gains, tame inflation, etc. — also work to aid the incumbent.

Consider the following chart, via Ned Davis Research:
click for bigger graph

We all fall under the spell of faulty logic sometimes, confusing what is cause and what is effect. As another example of this, consider the following:

“Obama is currently the presidential frontrunner. Note that, on Intrade, the market odds of an economic recession in 2008 are rising in tandem with the odds that Obama will be elected President. Correlation does not prove causation but this correlation is worrisome.”

All too often, we see the cause and effect relationship analyzed exactly backwards, as in the above example. These causative errors are an all-too-common analytical
blunder when reviewing market or economic data. Unfortunately, in seeking certainty in an uncertain world, confusing cause and consequence is an all-too-regular occurrence. The above quote is a perfect example of that foible.

To review: Markets are not skittish because the incumbent party is in trouble -
that’s getting it ass-backwards. When the ruling party is in election trouble, its because the future discounting mechanism of markets is incorporating a slowing economy into its pricing. Markets may be imperfect and subject to the excesses of crowd behavior, but they eventually get the big picture correct. The current market malaise reflects a recognition what is occurring in the macro-environment.

In the present case, its a weakening economy and the prospect of decreasing earnings that is most impacting equity prices. Slowing industrial production, a weak dollar, faltering consumer spending, high inflation, and $100 oil, weakening job creation and real income losses are factors that impact equity
prices — and the electorate — invariably hurting the incumbent party’s election fortunes.

People who are content with the status quo and secure in their
financial futures vote for more of the same; when they are not, they vote for change.

Thus, the Cause is the weakening economy and its discontents thereto. The Effect is the rise of candidates claiming to be change agents, and fall of those representing the status quo.

Want to see a good example of how politicians recognizing this economic discontent (aka “Cause”) ? Look at how often members of the incumbent party use the word “change.”

I’m a political independent — I supported McCain in 2000, and I would support a technocrat like Mayor Bloomberg today — but these arguments all smack of partisan cheerleading to me. I even recall back in 2004 that the same faulty argument was made in a WSJ editorial: “Kerry Up, Markets Down.” The Obama claim appears to me to be more of the same . . .


One final thought: Its even more spurious to rely on Intrade as a source of what is roiling markets. The presidential and political predictions markets are notoriously unreliable, especially far in advance of actual elections. But its not just far in advance: Recall how wrong the prediction markets were with Howard Dean and Iowa, and with the GOP retention of the Senate in 2006.

As of yesterday, the Intrade bet for Obama to win New Hampshire was over 95% — Whoops!:

Final settlement: Obama to win NH expired at 0.0.

To quote Dan Gross, these are “less futures markets than immediate-past markets.”

In an upcoming post, we will review the strengths and weaknesses of these thinly traded prediction markets . . .


Campaign Talk Gives Market Further Jitters
Promises of ‘Change,’ Economic News Blend To Unsettle Investors
WSJ, January 7, 2008; Page C1

Logical Reasoning Errors: The Dow Election Year Cycle
The Big Picture, Thursday, August 12, 2004

Obama, the Election and the Economy
Chicago Boyz, January 6th, 2008

Iowa and Prediction Markets
The Big Picture, January 24, 2004

Daniel Gross
Tuesday, Jan. 8, 2008,

Category: Markets, Politics

Open Thread: PPT to the Rescue?

Category: Economy, Markets, Politics

Game Over in Blu-Ray HD contest?

I’ve mentioned the Blu Ray/HD quandry in the past, but it seems the fight is drawing to its conclusion. In both the US and Europe, Blu-ray discs are significantly outselling HD DVDs.

But its this MacRumors chart (below) that pretty much sums up the battle:



Its hard to see how HD has a shot.

Now the question becomes how fast the prices drop on both the Blu Ray players and movies, but for now, I am sticking with an upconvert Sony for the big TV.


UPDATE: January 8, 2008 8:21pm

Why would prices go down?

As we previously discussed, I suspect many consumers have been on the sidelines awaiting the winner of the format war between Blu-Ray and HD.

As that fades away, the total number of purchases of the winner — Blu Ray — will go up significantly.

Thus, economies of scale, mass adaptation, and desires for deep market penetration will drive prices lower.

As to the monopoly issue — I doubt its an issue. 1) These are video playback toys, not an essential product or service; and B)  There is still legit competition from ordinary DVD players (fer cryin out loud, you can still buy VCRs for $29).   

My apologies for failing to explain the intermediate steps in my thinking  . . .

Category: Digital Media, Film, Technology, Video

Stock Trader’s Alamanac: Uh-Oh

Category: Investing, Markets, Technical Analysis, Trading

Real Estate Connect NYC 2008

Category: Real Estate

Pending Home Sales Index, NAR Housing Market “Bottoms”

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Merrill: Recession is already here

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If Presidential Candidates Were Stocks

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Headline of the Day

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Review: WSJ 2007 Forecasts

  > Last year, I participated in the WSJ forecasts. Given the typical Wall Street cheerleading, I (per usual) was the most bearish person on the list. As chance would have it, our forecasts were eerily accurate. Here are the forecasts from 2007 and the actual year end numbers: 2007 Forecasts DJIA: 13250; S&P 500:…Read More

Category: Investing, Markets