Wednesday, November 7, 2012

Did Obama's Re-election Tank the Markets?

Last night President Obama was re-elected to office.  Today the Dow fell 2.36% (312.95 points) to under 13,000 for the first time since August.  Certainly such a reaction is a strong condemnation of the Obama administration.

Or maybe it's not.  Economics has long held to the idea that the market is reasonably efficient.  That is to say that all public knowledge is already factored into stock prices. If this is the case (and a great deal of research indicates it at least mostly is) then why would the election of a president who was expected to win cause such a profound market reaction?

Here are some headlines from major media sources regarding today's market decline followed by brief quotes from the subsequent article:

Markets Plummet After Obama Victory Puts ‘Fiscal Cliff’ in Focus. "As I discuss in the accompanying video with Macke, Henry Blodget and Michael Santoli, the market is fearful that Obama's reelection means a continued stalemate in Washington, where the Republicans maintain control of the House."

Post-Election Retreat: Dow Plummets Below 13K for First Time in 2 Months. "As a result of the remaining sharp divisions in the White House and on Capitol Hill, market participants almost immediately shifted their focus to the looming fiscal cliff."

Bank stocks push Dow below 13,000. "This is purely a reaction to the political landscape and an investor response to the policies on the table -- all the new regulation that will add to the costs of doing business for certain industries and sectors"

All of these articles make mention of Obama's re-election and the approaching "fiscal cliff". Some then discuss other factors that may have lead to today's market decline.  However, these and many others ride the coat tails of election coverage to imply that last nights results, both presidential and congressional, had a large impact on today's market.

The fact is, last night's elections went essentially just as predicted.  Unbiased analysts with no interest in building tension or suspense predicted the outcomes of nearly every race with incredibly accuracy.  In short, there was very little in the way of surprises.

So if markets are reasonably efficient (price in already known information) and the results of last night's election were unsurprising than how can the outcome have had such a staggering effect on the market? Clearly there are other factors at work.  Briefly those factors include continued weakness in Europe, European Commision's growth predictions and strength in the dollar.

All of this is opinion and theory. Without solid backing my claim that Obama's re-election didn't have a meaningful impact on the market is as empty as other's claims that it did. So here is the math behind my theory.

Most unbiased analysts had Obama as a 90%+ favorite going into last night Source. To be generous we'll assume that the last time traders updated their political knowledge was November 1st when Obama was at an 80% chance for victory.  So Obama_Victory = .8 : Romney_Victory = .2.

Today the market fell 312.95 points. We'll assume that for Obama to be mentioned in virtually every financial recap article of the day he must be responsible for at least 150 points of that change. The market if reasonably efficient would price itself between where it would be if either candidate won with weight given to the likely winner.  Thus given our assumption we know that given 100% chance of Obama winning (since that is what occured) the market will fall 150 points (the amount of points we assigned credit for to Obama's election assuming the remainder was due to other factors) from yesterday.  In other words a 20% chance of Obama victory is worth -150 points on the Dow. Therefore if Romney had won (Obama_Victory becomes .0 or a change of .8) the market would have increased by 600 points.

Keep in mind at every pass we fudged the numbers to minimize this possible gain. If we assumed the market updated it's political knowledge more than once a week (it does) and that all or even a majority of today's market movement was due to election results we'd have come to a conclusion indicating market swings of up to 2500 points. Still even our generous 600 point gain has only been matched twice in the history of the market. Is it reasonable to think that a result that was expected could have such a profound effect?

I think not.

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