One of the most interesting phenoms of the Internet Era is the remarkable predictive value of synthetic trading markets like Intrade. My son did a study of the predictors of a movie’s success used by Hollywood, and found the synthetic trading market among Hollywood insiders was more predictive than the studio heads and all their models. These markets are of course widely used for predicting elections, and you can scan Intrade to see how your favorite candidates are doing.
Yesterday Joe Biden at a fundraiser quipped “You’re the dullest audience I have ever spoken to.” Normally a midterm election is fairly dull. A study shows that of the 27 midterms since 1900, the party in power only changed 7 times, and the change occurred in both houses of Congress only 4 times. The stock market appeared to be a non-factor. War is a bigger factor, with the change occurring only once in wartime (2006).
This one is anything but dull, and raises the core question for investors: does the switch in power have any predictive value for stocks in the next two years? Normally the two years into re-election are good for stocks:
Most investors remember how after the switch in 1994, the market took off in one of the greatest bulls runs in history. Based on the seven change midterms, one can say the market should be up: in the four where both houses switched, the market was up 3 times; and in the three when one house switched, the market was up one year later in two of those years, and up two years later in another two (but not the same two). Now, the market tends to be up; it is flat or up 80% of the time. When no change occurred in the midterms, the market was normative, up 80% of the time. Hence, these historical comparisons have too little statistical predictive value.
More important is the reason for the likely switch: a strong desire to cut spending and end the bailout culture. This suggests the new Congress will change course from the past decade of easy credit and large deficits. The more dramatic the change of economic policy, the more unpredictable the markets will be. And it seems increasingly likely that a major change will occur. For a while the Intrade markets have shown the House likely to switch:
Today the Intrade prediction of Biden’s party holding onto the Senate went below 50%: