Trader’s Narrative

With the arrival of the weekend, here is your chance to catch up on what you may have missed during the week. Check out news.tradersnarrative.com for interesting articles, news, reports, etc. from around the world.

Here’s a small sample:

• all that stands between you and becoming a great trader is 10,000 hours of practice (and a mullet)
• GM and Ford are doing great in South America - shhhh… don’t tell the UAW!
• what was Paulson saying 12 months ago about the economy?
• the Fed Funds rate may be at 1% but the effective rate is practically 0%
• the TARP bailout so far: list of firms and amounts pledged and/or received
• Canadian government gives their banks a small boost and may earn $190 million as a thank you
• retail sales = lump o’ coal

President-Elect’s First Weekly Video

The prediction markets and the polls were correct. Barack Obama is the next president of the United States of America. As a quick aside, America please accept my hearty appreciation and congratulations for your choice. If you listened carefully, just before the thunderous celebration across the globe, you heard a sigh of relief.

Putting aside today’s market slide of 5%, the important question is what does Wall Street prefer? a Democrat or Republican in the White House? Republicans’ reputation is of being more capitalist and business friendly, and the Democrats of being “tax and spend” as well as more prone to regulation. But just like the myth of gold as a safe-haven, the facts do not support this assumption.

Here is a chart showing different historical returns for the stock market under different administrations (source: Federal Reserve Bank of San Francisco).

The biggest outliers in recent history are, of course, Coolidge who’s presidency oversaw the 1925-1929 bubble and Hoover, who presided over the bust that followed. But even if we ignore these or by extension of the time horizon, go back far enough, the relationship still holds: Democratic presidents coincide with much higher stock market returns.

Another study that looked at the relationship between politics and investment returns was by Pedro Santa-Clara and Rossen Valkanov. Their paper titled “The Presidential Puzzle: Political Cycles and the Stock Market” was published in The Journal of Finance in October 2003. In it they show that during Democratic governments, the US stock market (between 1927 - 1998) provides an excess return of 10.69% above the 3 month Treasury Bill rates. While Republican presidents provide an excess return of 1.69% over and above 3 month Treasury bill rates.

According to Ned Davis Research the S&P 500 Index performs poorest in the first year of the four-year election cycle. Since 1900, the stock market does best in the pre-election year (11.3%) and the election year itself (9.5%). The pre-election year didn’t live up to its historic pattern - to say the least!

Here is a recent visualization from the New York Times, showing 80 years of market returns:

Source: New York Times

If you aren’t satisfied with this myth being upended, here is an interesting tool that lets you make different assumptions about the stock market returns under different administrations. For example, you can check what would happen if we include dividend reinvestment. Or what about the effects of inflation? And time lag for policy effects? You get the idea.

President-Elect Barack Obama
In case you didn’t catch it, here is Obama’s victory speech (putting Cicero to shame).

There are just a few days left until we know who the next President of the USA will be. Here are two aggregations of multiple polls:

FiveThirtyEight is a relatively new site which has gained a lot of attention because of their methodology. They assign each poll a weight based on its historical track record, the sample size, and the freshness of the poll.

They run a regression estimate based on the demographics in each state to account for outlier polls and to put the data its proper context.

Finally, 528 simulates the election 10,000 times for each update to provide a probabilistic assessment of outcomes based on a historical analysis of polling data since 1952.

The end result of all that? FiveThirtyEight is giving Obama a +96% chance of winning the election. This number fluctuates daily as new data is integrated. You can watch this and other information here.

But since this is a trading blog, lets take a look at the electronic markets where people don’t just give an opinion, they back it up with cold, hard cash. These “prediction markets” are also favoring Obama by a landslide.

Here is the intrade contract for Barack Obama, implying an 85% probability of winning:

Here is the Iowa Electronic Market for the US election, winner take all:

And here is betfair:

It seems like everyday another prominent Republican endorses Obama. People it seems, question his judgement, age and the tone of his campaign. The first and second go together because of his pick for VP, Sarah Palin, of course.

At first Palin energized the ailing McCain campaign but as people have gotten to know her more, she has become one of its biggest handicaps. From not knowing what the constitutional role of a VP is (”in charge of the US senate”), to wearing a $150,000 wardrobe and $22,000 make up artist while claiming to be a hockey mom, to not knowing what the 1st amendment means, to believing that the pledge of allegiance was written by the founding fathers, to not being able to name any media she reads, to not knowing any Supreme court cases other than Roe v. Wave, to not knowing the Bush doctrine…. need I go on?

I can’t blame anyone for being scared of this woman’s ignorance. As an average Canadian, even I know more about the United States and its constitution that her!

Who Wins? Who Loses?
Under an Obama administration the winners are clear, infrastructure companies, alternative energy companies like solar, wind, water/wave, etc. Defense spending and homeland security as well as big oil may have to butter their bread a little less.

What is amazing to me is that while the data historically has shown that Democratic governments have been a boon to the US economy, lowering unemployment, the deficit and even ushering in bull markets, the Republicans somehow have the image of being business friendly. Go figure.

While Obama’s provenance and religious leanings have been questioned, I find it rather odd because I find that that is one of his best strengths on the international front. Can you imagine the amount of goodwill that will be engendered in the Muslim world when the face that represents the people of the United States of America looks like them? What do you think that will say about the unity and diversity of the US? about its capacity for meritocracy? Maybe you Americans have never thought about it that way, but believe me, as an outsider, that is a major bonus that Barack Obama has.

Not that you should be voting for him based on that. Not at all. Vote based on the candidates’ judgements, platforms and ideas. If you are a US citizen, VOTE !!

Ronald Reagan Endorses Obama

Ronald Reagan did in fact endorse Obama. Ronald Prescott Reagan that is, the son of the former POTUS.

The only person it seems who hasn’t endorsed Obama is John McCain himself. Wouldn’t that be the ultimate move from a true “maverick”? to endorse your own opponent?

Below is the chart for the brand-new market on whether Sarah Palin’s vice-presidential nomination will be withdrawn:

You can see the complete page at intrade here.

If you think that Palin will be John McCain’s running mate, then you would sell and pocket the difference as the market settles to zero. If you think that she will be replaced, then you would buy and pocket the difference when the market goes to $1.00

So right now this market’s conviction is that there is about a 15% chance for this event. To see what I mean, check out the chart of the market for Palin’s nomination:

As the chart shows, the nomination came out of left field but those who had bought made a lot of money!

Although many call these markets “prediction” markets, they aren’t crystal balls that perfectly foretell the future. They simply reflect all available information at a specific point in time. For example, check out what they were saying during the Democratic and Republican nomination process for president.

The Iowa Electronic Market is another well-known “prediction market”. You can see the graph of the presidential race here.

Rove could teach Machiavelli a few tricks. But he isn’t infallible by any stretch of the imagination. In classic Rovian style, he brought in Sarah Palin to persuade disenfranchised Hillary Clinton supporters to vote for the McCain ticket. He knows that the GOP desperately need the woman’s vote to stand a chance in this election:

As one McCain aide put it: “We either get Hillary’s voters and we win, or we don’t. It’s not a mystery.” Said another: “This campaign is all about the middle.”

But he accomplished more than that. With Palin, he also makes it politically incorrect for either Obama or Biden to go after McCain’s VP because she is a woman. It would look unseemly to have two seasoned, eloquent politicians wipe the floor with an attractive mother of five who has no experience and no relevant qualifications.

Here is an easy way for the Democrats to checkmate Rove’s move: Have Hillary Clinton rip Sarah Palin apart.

She is more than capable. If she devotes half the tenacity she showed in the Democratic party nomination process, Palin doesn’t stand a chance.

She is the only person who can do this. Not only is she the right gender, she is eminently more qualified, experienced and educated. If I were advising Obama, I’d have him suggest the possibility of an appointment, say, Secretary of State - depending on how well Hillary demolishes Palin in the run up.

Oh, and by the way, three years ago we were told that Katrina was God’s punishment for all the sin in New Orleans. So how are we to interpret Gustav interfering with the GOP convention this year?