It seems like most commentators are either cocksure or dismissive about the hypothesis that recent political developments explain the drop in the stockmarket. The wisest appraisal is surely somewhere in between. Correlating specific day-to-day drops (or rises) with political announcements is often misleading. I think a few moments in the stock market's slide seem attributable to political events. The fall in the Dow on the day of Obama's election seems an obvious case: it was a huge event for the economy, making it implausible that something else bigger happened that day; the event was not known with certainty beforehand; and the magnitude of the drop was larger than the range of normal volatility in that period. There were a couple of other cases.
But these details don't really matter. Financial economists often conduct "event studies," to try to determine how certain events impacted stock prices. The events in question are usually the announcement of quarterly profits or of a merger, events specific to one corporation with little impact on broader markets. Obama's 2008 victory, or the announcement of the stimulus bill, are not, as far as I understand, the kind of events that could be subjected to an event study. There's too much noise, and it's too hard to figure out what the market really knew, when. The question of whether a decline in stock markets over a somewhat longer period of time, say, the entire drop since mid-2007, is due to political events, and to what extent, is both easier and harder. On the one hand, the 'who knew what when?' question is less important, for there's obviously a huge amount that markets didn't know in mid-2007 that they know now. On the other hand, so many things have happened that it's impossible to use the timing of market movements to tease out causation stories. It has to depend on your model.
Jon Chait is in the dismissive camp:
The one conservative talking point that has gotten the most traction since Barack Obama won the election is that he's killing the stock market with his big-government agenda. Conservatives pundits started saying this in November, and mainstream news implies it constantly. "Stocks are down almost 19 percent since the Obama administration took office," reported ABC News recently. MSNBC has been endlessly featuring a graph of the stock market's decline since Obama took office. While Obama's economic policies have gotten plenty of things wrong, the idea that they can be judged by the stock market is unbelievably fatuous.
"Unbelievably fatuous." No, it is certainly not that. The argument requires (a) that Obama, and/or the anticipation of Obama's victory, and/or the Democrats and their increased majorities in Congress, have caused, or contributed to, the fall, and or failure to rise (because the Dow might be back at 14,000 now under President McCain for all we know), of the stock market, and (b) that a strong stock market is important to the health of, and/or the best single predictor of the future prosperity of, the economy. Both claims are extremely plausible. Chait goes on:
To understand this ubiquitous notion, let us start at the bottom of the conservative intellectual food chain and work our way up. The crudest version of the Obama Bear Market hypothesis is put forward by the likes of Rush Limbaugh, Sean Hannity, and Fred Barnes. Their favorite data point is that the market tanked at several key moments: the day after the 2008 presidential election, the day of Obama's inauguration, and the day he signed the economic stimulus bill. Clearly the markets panicked in reaction to Obama's incipient big-government, wealth-confiscating agenda, right?
Sure, unless you realize that those events just might have been priced into the market already. Obama, in case you forgot, was considered a lock before Election Day. (On election eve, Intrade had given Obama a 92 percent chance of winning.) Likewise, the vote that made the stimulus bill a fait accompli took place several days before the bill's signing. The real market-driving news came even earlier, when Obama unveiled his plan. Contemporaneous reports on the market reaction-The New York Times, December 9: "WALL STREET SURGES ON STIMULUS HOPES"-dug up little evidence of fears about socialism.
You may not believe me that pundits are citing the market's drop on January 20 as an indictment of Obama. It's true! "The Dow fell 332.13 points on inauguration day," noted Barnes, holding this up as evidence that "The market's view is that an Obamanomics-driven economy looks grim." I'm trying to figure out the operating theory here. One possibility is that, before January 20, investors thought Obama would get cold feet, or that maybe President Bush would surround the White House with tanks and stay forever. Alternatively, the markets did know Obama would assume the presidency that day, but got really depressed when it actually happened. Neither of these possibilities speak well of the stock market as a rational gauge of the country's economic future.
On the last point, the hypothesis in question is surely that what Obama said (namely a real downer of a speech with a lot about "icy waters") that depressed the stock market. In general, though, Chait is shooting at straw men here. Specific events will naturally be taken as illustrative of a trend, but it's the trend that counts. The Election-Day and Inauguration-Day would not be cited so often if they were aberrations from an upward sweep in the stock market since Obama's election. Chait argues later:
American stocks are merely suffering the same drop as stocks in countries not subject to Obama's socialist agenda. While the Dow did fall by 25 percent over the first two months of 2009, the Global Dow fell by 26 percent. If Obama's agenda was the problem, then you'd think U.S. stocks would fall further and faster.
This is not valid because the movements of world stocks are highly correlated. As far as I know, we don't have a really good understanding of why this is, but it implies that if "Obama's socialist agenda" is depressing stocks here, it will tend to do so throughout the world. In fact, during the financial crisis last fall, almost all world stock markets fell more, in many cases substantially more, than Wall Street, even though Wall Street was clearly Ground Zero of the financial crisis. Also, recent history suggests that this global capital-market interdependence is one-sided. In the late 1990s, world stockmarkets were also crashing-- remember the Asian crisis? the Russian default? the Brazilian crisis? Argentina?-- but Wall Street was flying higher than ever. So while the global drop in stockmarkets would seem to be a consequence of the US decline, the US could buck a global downtrend if the political/policy environment were pro-growth.
Chait has another argument:
The larger fallacy here is to assume that the stock market is a proxy for the entire economy. Many people realize that the stock market is an imperfect gauge. But it's not just an imperfect gauge of the economy-it doesn't even attempt to measure the economy. Stock prices represent the market's guess at the profitability of corporations. While that's related to the health of the overall economy, it's not the same thing, and sometimes the two diverge sharply. During the Bush administration, for instance, corporate profits soared while wages for most families flatlined.
Wages flatlined because of rising health care costs. Rising compensation was taking the form of health benefits rather than wages. And note that now, when corporate profits are falling, workers are getting hard hit too. The 1930s were also bad for corporate profits, and for wages. The idea that you'll reduce corporate profits while benefiting workers is probably a delusion, and it can certainly motivate a lot of destructive policies. To the extent that a low stock market discourages capital investment it also reduces wages in the medium run, since labor is complementary with capital and is more productive, and therefore gets paid more, when capital is abundant. There's really no such thing as "bad for capitalists, good for workers."
The other thing about the stock market is that it is forward-looking. Wages are slow to adjust to news, good or bad, as are many prices. So are investment and employment. But the stock market spontaneously compiles the guesses of millions of people about the economic future. The stock market is the canary in the mine shaft.
A falling stock market harms the economy on the demand side because it makes people poorer. "Americans See 18% of Wealth Vanish" (WSJ):
The wealth of American families plunged nearly 18% in 2008, erasing years of sharp gains on housing and stocks and marking the biggest loss since the Federal Reserve began keeping track after World War II.
The Fed said Thursday that U.S. households' net worth tumbled by $11 trillion -- a decline in a single year that equals the combined annual output of Germany, Japan and the U.K. The data signal the end of an epoch defined by first and second homes, rising retirement funds and ever-fatter portfolios.
Past downturns have been mere blips compared with the losses Americans faced last year, which set them back to below 2004 levels. "In the postwar period, we've never had anything other than very modest declines. That life experience led many people to think that houses were a one-way bet," says Douglas Cliggott, the chief investment officer of Dover Management LLC.
The decline in Americans' net worth, which was the first in six years, follows an extraordinary boom. Not accounting for inflation, household wealth more than doubled from 1990 to 2000, and then, after a pause, rose nearly 50% before the bust of 2008.
While the value of their assets was falling, Americans' total debt remained roughly flat. Total household debt increased by half a percentage point in 2008 as families faced tighter lending standards and many started trying harder to live within their means. After years of splurging with an eye on their rising assets, that phenomenon, known as the wealth effect, now cuts the other way, spurring frugality.
The goal of Obama's "stimulus" measures is to encourage spending. But if people try to smooth consumption over their lifetimes, as much evidence suggests that they do, then they will decide how much to consume by first estimating their lifetime income (including net worth minus intended bequests) and then consuming some share of it. If their expected lifetime income falls, they will consume less. So a stimulus bill that causes a decline in the stock market probably ipso facto fails.
Which brings us back to the question: Did the stimulus bill, and Obama's Big Deficit agenda generally, cause a decline in the stock market? Nothing conclusive can be deduced from the mere stockmarket time series. But the theoretical reasons to think that America's capital stock is worth less when the government is borrowing and spending a lot are strong. First, if you think about capital markets, government bonds compete with stocks for investors' dollars, and a greater supply of the T-bills would seem to mean fewer dollars left to buy stock in Microsoft and Caterpillar. Second, higher deficits presumably mean that future taxes will be higher than they would have been. This need be of little concern to seniors who don't expect to be alive then, and may not much affect the behavior of credit-constrained people who spend whatever they can get. But to people who are thinking about the future and planning projects that will incur costs now to create value later, it is hard to see how the fact that a large amount of that value-later is likelier to be confiscated could fail to effect their calculations.