Will Dow's gyrations determine race for White House?

by Adam Shell, USA TODAY - Sept. 18, 2012 06:54 AM

NEW YORK -- History has shown that a favorable 50-plus approval rating is pretty much a prerequisite for a president to get re-elected. Another time-tested path to the White House for the incumbent is to have the economy expanding and the unemployment rate shrinking leading up to the election.

But what voters and investors might not know is that what happens to stocks on Wall Street in the two months leading up to Election Day may be the best predictor of who gets elected president, according to James Stack, president of InvesTech Research.

The math basically works like this: if the Dow Jones industrial average goes up in the period from roughly Labor Day to Election Day, the incumbent president or party will likely retain control of the White House. If stocks head south in that key period, the challenger will likely stage an upset win.

In fact, in presidential elections since 1900, the direction of the Dow has accurately predicted whether the incumbent party retains its grip on the presidency nearly 90% of the time. This barometer has been accurate 25 out of the past 28 times over the past 112 years, according to Stack's data.

"A lot of investors think the election or politics determine the outlook for the market," says Stack. "But there is a remarkable past link where the stock market appears able to predict who will win the White House."

The logic goes something like this: a rising stock market normally reflects investors' belief that the economic outlook is brightening. And an improving economy often coincides with rising confidence among investors and voters, which boosts the odds of the incumbent winning.

For now, the edge seems to be in favor of President Obama, as the Dow has skyrocketed 517 points, or 3.9%, since Sept. 4, helped in large part by an aggressive campaign by the Federal Reserve to get the economy moving again and spur job growth. The Fed's launch on Thursday of its third round of bond buying, dubbed quantitative easing, or QE, to keep rates low to stimulate growth put the market in rally mode.

But Republican challenger Mitt Romney shouldn't be counted at just yet. There is still a slew of economic data to be released prior to the election -- including the September and October jobs reports -- which could dent confidence if they're lousy and cause stocks to turn back down. There's also the specter of the looming fiscal cliff for a potential growth-stunting combination of tax hikes and spending cuts -- to turn the fledgling optimism about the economy back to pessimism again.

In short, the election will be held hostage to fresh reads on the economy's health.

"We have 50 days to go," says Barry Knapp, head of U.S. equity strategy at Barclays. "The question is: Will we get any other additional catalysts (other than QE3) to boost stock prices going forward?"

Edward Yardeni, chief market strategist at Yardeni Research, warns that the Fed's moves won't solve all the economy's problems. "QE3 is not going to solve the fiscal cliff," he says. "There's also a risk that the market sells off on the realization that QE won't help the economy."