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November 23, 2008

Comments

Nato

it's true they didn't say "Oh, well then, it's all better now."

Tom

Actually, I would say the markets went up right before the election because everyone expected that Obama was going to win. But clearly, Obama optimism is not sufficient by itself to right the ship. Right after the election, the sell-off was simply profit-taking.

Nathan Smith

"Profit-taking." Heh. It's just "the stockmarket fell, nobody knows why," dressed up with a meaningless phrase to make it sound like an explanation rather than a shrug. The concept of "profit-taking" as a reason for the market to fall makes no economic sense.

However, I think it might actually be true that the stockmarket went up before election day because people expected Obama to win, and then went down because he won. First investors were thinking, "Good, this wretched election is finally over..." and that got them in a buying mood. Then they were like, "Whoa! Who is this guy we just elected? What the heck is he going to do? Oh no! AAAAAAHHHH!!!!..."

If investors got optimistic about McCain's chances at the last minute, that makes them look at least sort of rational. If investors were buying because they thought Obama was going to win, and then selling because he did, that makes them look pretty silly. But then, in view of what 60 million people did on Nov. 4th, any hypothesis that is based on the idea that masses of people are silly is looking really plausible just about now.

If McCain had won, I think the stockmarket would be 10,000 or 11,000 now. But maybe not. There might be a danger of civil unrest.

Nato

I think Tom's explanation makes as much sense as any.

What I think might be genuinely interesting is how markets respond to today's announcements about Obama's economic team. I'm not really pleased by them, but I think the market may well be.

Nathan Smith

re: "I think Tom's explanation makes as much sense as any."

Dude.

The market went up because the market thought Obama was going to win.

Then plunged because he won?

Oh wait, no, it was "profit-taking." But please note: the phrase "profit-taking" never makes much sense as an explanation of market movements. Of course an individual seller might say, "I've made some money, I'll take my profits now," and sell. But he might also say, "Good, I've made some money, now let me make some more." And someone who's not in the market might say, "People are making money-- I want to get in on the action." In a market with millions of investors, all these individual idiosyncracies will offset each other and should not cause market movements.

Of course, there *is* a situation in which unusually large numbers of investors, enough to move the market, will "profit take." Namely, if there's a widespread expectation that prices will not rise further and may fall, so they should sell while the selling's good. But this psychological explanation at the level of the individual investor begs the question. The real question is the same as it was before: why did the market's expectations turn?

Now, Tom's explanation of the post-Obama plunge as "profit-taking" is nonsensical from the merely semantic point of view: people who bought into the election-day rally and then sold at the end of the next day would have taken losses, not profits. That's why financial journalists typically use the term "profit-taking" to explain modest backsliding after a rally, not steep reversals that more than offset the rally. The limb Tom is going out on will not bear any weight.

Substantively, however, "profit-taking" is never a meaningful explanation of stockmarket movements. The question is: why did expectations improve so much on election day, then deteriorate so much the day after, when the main news of election day-- Obama's win-- was widely expected? An explanation that is consistent with market rationality-- not necessarily a strong point in its favor-- is that the market decided at the last minute that McCain just might win, and disappointment sparked the sell-off. Tom's explanation that the stockmarket rallied because Obama was expected to win isn't completely implausible. But if you say that, you have to accept the corollary that investors changed their minds and got spooked when it actually happened (anticipating the buyer's remorse that the electorate is likely to take longer to arrive at). The verbal fig-leaf of saying the sell-off was "simply profit-taking" is especially risible when the sell-off was bigger than the rally.

Nato

Profit taking isn't only or even usually after a rally. It's just a sell-off after a rise, so as to lock in gains. I agree that it's a fairly empty term, since the standards for its use (as opposed to a drop on bad news or whathaveyou) are so ill-defined. The two-day sell off after Obama's election caused price declines smaller than the previous run up from ~8200 to ~9600, so if one picks and chooses one's timelines, then one can end up arguing many different stories. I think that's the point, here. If one picks the timelines one way, then yes, Obama's election can look like a singular event. Picked another, it looks like a singular event with a different meaning. Picked another way (the one I favor), it doesn't look like much of anything at all.

Nathan Smith

re: "if one picks and chooses one's timelines, then one can end up arguing many different stories."

But not Tom's.

Nato

Incidentally, the market is up today. Most people seem to mark this down as due to the Citi Rescue, but I'm going to award it to Obama's economic team, because that's the story I want to tell.

Nato

If we can't have Tom's story, then I think we'll have to throw out Nathan's, which asks us to believe that the market either somehow didn't fully expect Obama to win despite all poll evidence and despite the overwhelming Intrade spread, or that the market didn't price in his expected win, and that the main surprises to anyone paying attention were not the apparent retention by Stevens and Coleman of their Senate seats and Young of his House seat. The only surprise in the Dems' favor was Obama taking Indiana, but this produces no material effect of the likely legislation coming down the pike. Maybe the markets were depressed by the unexpected passage of prop 8, which did do some damage to California's economy. It seems about as plausible.

Nathan Smith

re: "If we can't have Tom's story, then I think we'll have to throw out Nathan's, which asks us to believe that the market either somehow didn't fully expect Obama to win despite all poll evidence..."

OK, let's see if you can understand this.

Odds of a McCain win on Nov. 3rd. Positive. Pretty small, according to Intrade, 10% or something. Some pundits thought McCain had a chance. Investors could have thought the odds were bigger.

Odds of a McCain win on Nov. 4th. Zero.

A rational market would not "fully" expect Obama to win on the day before (if "fully" means 100% expectation; if it doesn't mean that, it's meaningless hand-waving). The Obama win was new information. The following hypothesis can therefore be formulated.

1. Value of stockmarket | McCain wins = (say) 11,000.
2. Value of stockmarket | Obama wins = (say) 8,000
3. Probability | McCain wins: 33%.
4. Value of stockmarket | election outcome unknown = 33% * 11,000 + 67% * 8,000 = 9,000.

This model would predict a stockmarket drop of 1,000 points once the news of the Obama win became known. That doesn't mean it's right, not even close. It does imply that there must have been a swing in market sentiment on the day of the election in favor of thinking a McCain outcome was, not likely, but more likely than was thought a few days before. It's not clear why the market would have had such an expectation. Did they let the self-serving musings of a few conservative pundits get their hopes up?

Anyway, one can't learn much with confidence from reading the market tea leaves, but one can sort stories into the tenable and untenable. The "Obama market" story definitely falls into the former category and don't let anyone tell you it doesn't. Tom's story falls into the latter category. Its logic can't be explained because it isn't there.

Nathan Smith

One more thing. Even if McCain didn't win, a 50-50 election, like 2000, might have been good news, because it might have influenced how Obama would govern. Obama's margin was news, and could have spooked the markets.

Nato

If "the market" thought there was a 33% chance of McCain winning, then I would conclude that "the market" is pretty stupid.

Nathan Smith

Well, if you prefer, let's say the market value in the event of a McCain win is 14,000, the level before the Democrats took Congress in 2006, and the odds of a McCain win were 17%. Anyway, the point is that one may hypothesize a set of expectations by investors along these lines that would explain the market movements. In that sense, the story is logically coherent, if not necessarily probable. Tom's story fails this logic test.

Nato

Are there any scenarios in which the market's behavior around the election time both 1) owes primarily to judgments about the probable meaning of the election results and 2) avoids making the market seem foolish and thus of dubious judgment?

Tom

My comment was mostly a parody of Nathan's, but it has the added benefit of also being more plausible considering most of the world wanted and expected Obama to win. Maybe an even more plausible reason for the gains before the election is that money is added to retirement accounts around the beginning of the month (and maybe also the middle, if being paid bi-weekly). Smart investors probably buy right before this period and then sell right after. I haven't actually checked, but I imagine most months follow this sort of pattern.

Nathan Smith

re: "it has the added benefit of also being more plausible considering most of the world wanted and expected Obama to win."

I guess I shouldn't take the bait. Let's just say most of the world aren't the people whose wealth Obama promised to spread.

Needless to say, most months don't see swings of over 1,000 points around the beginning of the month. If so, you could make a killing by buying the predictable rallies and declines.

To Nato: I think it would be hard to meet the criteria you set. If I had to guess, I'd say the market wasn't all that rational: it failed to price in-- or rather, it priced in but then priced out again-- the likely Obama win because investors didn't quite believe it until it happened. He seemed unreal, like a bad dream.

The reaction to the Geithner appointment, and Summers and some other figures, is encouraging, but at the same time suggests the market may have had pretty low expectations of Obama. So he's appointing some smart, fairly centrist, economists. It's an obvious move. What did they expect from him that this is so reassuring? Given his resume, though, it's hard to say what kind of expectations would be too low.

Nato

I think a lot of folks thought that, with Congressional supermajorities so nearly in the bag and a huge crisis to justify drastic measures, Obama would rule from the left. Large portions of the left are hopping mad at him for not cashing in on the opportunity to dance the FDR.

Tom

There are a couple other things at play that deserve mentioning:
1) Margin calls. People are being forced to sell because they purchased stock on margin. This causes stock prices to decline further, which leads to more margin calls. It's a nasty cycle to get into. Also, it makes one wonder what the true value of the market is if much of the stock is purchased on margin. Debt is directly inflating stock value, and when it's time for debtors to collect, that stock value vanishes.
2) Retirement account payouts. This would have the opposite effect of the money being added to accounts that I mentioned earlier. Unless these two effects happen fairly close in time to each other, they're bound to create a predictable periodic gain and decline in stock prices. On the other hand, it's possible that fund managers spread out stock transactions uniformly across each month, and if that's the case, then there would be minimal short-term effects on stock prices from retirement accounts.
3) Deflationary pressures. Housing, stocks, and commodities have all devalued, and the dollar has increased in value. These are deflationary effects. If the market expects the dollar to be more valuable in the future than it is now, then there is incentive to save dollars rather than spend them. If dollars are being saved rather than spent, then commerce decreases and the economy slows down. The value of debt in dollars also increases as the value of the dollar increases. Thus the economy is getting hit with a double-whammy of declining assets and increasing debt. Nathan made an earlier post about printing more money, and such a move would definitely alleviate some of the deflationary pressure.

Because of all of these points and others made on this blog, I highly doubt that stock market movements are much correlated with election expectations.

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