If the stock market continues its surprising rally, Mitt Romney may be nothing more than a rich investor after the November elections, while President Obama gets started on a second term.
That's the implication of an updated study on the effect of the stock market on presidential elections, which found a strong correlation between positive stock-market returns and the re-election of the incumbent when a sitting president is running for a second term. "Large stock market advances during the final three years of incumbent candidates' terms tend to be strongly associated with subsequent landslide victories," says the report from the Socionomics Institute, a research firm in Gainesville, Ga.
It's hardly a revelation to suggest that a rising stock market boosts the re-election odds of an incumbent president. But the Socionomics research goes a step further by comparing the stock market to other factors such as unemployment, economic growth, and inflation—which, it found, have surprisingly little influence on presidential re-election bids. "The importance of these other variables remains relatively weak or insignificant when examined in combination with the stock market," according to the study.
The Socionomics Institute is run by Robert Prechter, a controversial forecaster and social theorist who has been predicting a stock-market crash for several years. Prechter is also the lead author of the paper, which examined the stock market's effect on U.S. presidential elections all the way back to 1824, when the necessary data was first available. Some modern examples that validate the theory are Ronald Reagan's 49-state win in 1984 (preceded by a 42 percent stock-market gain over the previous three years) and Bill Clinton's 1996 landslide victory (preceded by a 64 percent gain).
The stock market is a potent indicator not because most voters own stocks, but because it reflects the public mood and the overall direction of the economy. A rising stock market may even contribute to confidence and the sort of positive feedback loop that makes consumers and business feel more upbeat, while a falling market does the opposite. That feeling of optimism or pessimism ultimately redounds to the nation's political leader, whether deservedly or not.
If the pattern holds, Obama ought to replicate the Reagan and Clinton victories, since the Dow Jones Industrial Average has risen by 40 percent over the last three years. "Mr. Obama would have a strong probability of winning a second term if the election were held today," Prechter says. "But a lot can happen in the stock market from August through October, as we experienced in 1987." That's the year stocks fell by 23 percent in one day—for reasons that still aren't fully understood--and took more than a year to recover.
Even if the recent rally continues, the Prechter correlation could be severely tested this year, since it seems obvious that Obama won't enjoy anything like a landslide victory. Polls show him slightly ahead of Republican challenger Romney, but the race is so close that Romney could easily pull ahead. The weak economy is clearly holding Obama back and could doom his second term altogether. Most other presidents who have been re-elected haven't had to contend with the kind of unemployment Obama must explain to voters. When Reagan was re-elected in 1984, the unemployment rate was 7.4 percent and on a clear downward trend. Clinton faced an unemployment rate of just 5.2 percent in 1996. Today, unemployment is 8.3 percent, and it has been drifting upward. There will be three more official jobs reports before the November elections, and while they might show a mild uptick in hiring, it's unlikely the unemployment rate will fall much before Election Day.
The stock market is also a wild card that has defied expectations recently, with a summer rally that has occurred despite signs of a slowing economy and other worrisome developments, such as the ongoing debt crisis in Europe. Some analysts, including Prechter, think a pullback is coming, perhaps in time to sink Obama's re-election bid. Others, however, think a new bull market could be kicking off. Investing firm Piper Jaffray, for instance, recently predicted that stocks will gain more than 40 percent over the next two years.
It's also possible that this year's election could simply diverge from the historical trend. It has happened before. The stock market rose by about 24 percent during the last three years of George H.W. Bush's presidency, yet he lost his 1992 re-election bid to Bill Clinton. The main reason: a recession followed by a weak, "jobless" recovery, just as we have now. Maybe a new historical trend is forming.
Rick Newman is the author of Rebounders: How Winners Pivot From Setback to Success. Follow him on Twitter: @rickjnewman.