Thursday, February 21, 2008

Kudlow, Paris and the meaning of primaries

I love talk shows.. I find them the perfect cure to the mental strain of a 12-hour work day, with their easy-listening blabber on such important topics as the Presidential primaries, Sister Spear’s pregnancy or the secrets of the perfect orange marmalade. I have even developed an addictive affinity for the various characters that host these things, and their spells of wit, insights and, yep, a lot of trash.

One of these latter occasions happened last week, while I was at the gym about to lift 8 pounds of weight with each arm—my first ever attempt to cross the 5-pound barrier! I had long prepared myself mentally for this landmark step in my body-building efforts, and I can only blame one thing for my spectacular failure: Larry Kudlow on TV, expounding his latest “theory” on stocks and politics.

For those of you who don’t live with the privilege of 24-hour CNBC at work, Larry Kudlow is the host of CNBC’s Kudlow & Company (daily, at 7pm New York time), a show dedicated to the laudable cause of promoting capitalism as the path to global prosperity. Besides his TV persona, Mr. Kudlow (can I call you “Larry”?) is one of the highest-flying "non-economist economists" (an economist without an economics degree): He runs an economics consultancy firm, hosts a radio show and goes around offering his thoughts on supply-side economics, though for a bit more than a penny! He is also someone who, under certain circumstances, can talk sense.

Not last week. Some weird constellation led him to put forward an interesting thesis: John McCain as the driver behind the recent “mo” in the stock market!

It may be a coincidence,” he began, but “John McCain wins decisively in South Carolina on January 19th, he then wins decisively in Florida on January 29th. In between the stock market finds a bottom, which we date to January 22nd, and shares are up 3 percent, and looks to have an upward momentum. Is there a relationship? Is this the McCain-stock-market market?”

Amazingly, he said this with a straight face. And he was not alone. With him were three pundits, two CNBC contributors and one acclaimed economist, Arthur Laffer, all of whom built on the “McCain-stock-market market” case with the same straight face and dubious argumentation. Even Laffer himself, the economist economist!

Well, guys, I don’t know what kind of statistical analysis you did there with just two data points, but I’d say your theory competes in rigor with, let’s say, the weather.. Surely, the fact that we had above-normal temperatures from January 23rd to the 29th must have played a role? Not to mention the reverberations from Paris Hilton’s nomination as “woman of the year” by Harvard’s Lampoon magazine!

Statisticians will tell you that in order to establish a “relationship” you’d better have a lot of data that go sufficiently back in history and that allow you to identify regularities with a decent level of confidence. So that after many observations you could confidently maintain that you if heat water up, it will boil; if you lower interest rates, credit will tend to rise; if you buy your wife flowers, she might forget about those dishes you promised to wash.

In this spirit, numerous (economist) economists have spent years trying to establish whether any relationship exists between electoral cycles, partisanship and stock-market performance. Unlike Kudlow & Co., some have used data going back decades, and pretty sophisticated tools with such impossible names as Markov-switching or “Generalized Autoregressive Conditional Heteroskedasticity” models (I’ll buy dinner if you can say the latter five times flawlessly and without breathing… And no, you can’t say GARCH!)

So what have economists found? A number of things, though, as usual, they don’t always agree with each other. Some(1) have found that stock prices move in line with the presidential cycle—weakest in the first year after an election and highest in the latter half of the presidency, regardless of which party is at the White House. Some have found that when investors are uncertain about the outcome of the Presidential elections, stocks are more volatile. When it comes to partisanship, some(2) have argued that, on average, stocks have performed better under Democratic administrations—though these results have been challenged but yet more economists on methodological grounds.(3)

Where does this leave us? Well, if the world were as monolithic as some primaries-focused journalists would like us to believe, you might actually want to sell your stocks now and buy again during the first year of the next administration—the year it’s supposed to “bottom.” Another politics-driven bet would be to trade the view that stock price volatility will continue until there is a clear Presidential winner with a clear set of policies.

But, in case some haven’t noticed, there are a few other things going on in both Wall Street and Main Street besides the elections and the presidential cycle. From foreclosures to credit crunches to bank losses to job losses to sky-rocketing oil prices to Warren Buffet’s “indecent proposals” to the ailing bond insurers. And with all that going on, my guess is that markets are almost as nonchalant about McCain’s Republican lead as Paris Hilton (who, upon hearing the word "primaries," she inquired “what does that mean?”)

Besides, here you have in McCain a candidate who publicly admitted that economics is not really his forte! I mean, come on Larry, you didn’t really want to say that markets dislike economists? Because, that’s just impossible to believe!

Glossary: presidential cycle theory, confidence level, stock returns, stock volatility, GARCH.

Interesting Links:

Political Wheel of Fortune: Is Wall Street tied to the Presidential Cycle?

Paris Hilton on the Primaries

1/ e.g. Y. Hirsch, M. Gärtner & K.W. Wellershoff, W.K. Wong & M. McAleer

2/ e.g. Santa-Clara & Valkanov

3/ e.g. S. D. Campbell & C. Li

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