Can the stock market pick the next president?

New York: The number has been repeated so often by presidential prognosticators that it's an article of faith: No president has been re-elected since the Second World War with an unemployment rate higher than 7.2 per cent.

But the stock market turns out to be a pretty good predictor, too.

The Dow Jones industrial average has soared 62 per cent since President Barack Obama took the oath of office during some of the darkest days of the Great Recession. The Dow was just below 8,000 then and stands near 13,000 today.

If a recent study of stock markets and presidential elections is any guide, Obama can start preparing his second inaugural address.

"There's something to this," said Phil Orlando, chief equity market strategist at Federated Investors, the $370 billion (Dh1.3 trillion) investment firm.

There are plenty of other signs often consulted for their political forecasting power, like whether a team from the National Football Conference or the American Football Conference wins the Super Bowl.

This one makes a little more sense: When the economy picks up and unemployment falls, confident investors put money into riskier investments and stocks rise. Voters are likely to reward the sitting president with another four years.

"The stock market reflects trends in the economy," Orlando said. And as any political operative can attest, in a presidential campaign, it's the economy — you know the rest.

The study was backed by the Socionomics Institute, a think tank studying how a shared mood among a group sways its members' actions. Their researchers dug up data on economic output, prices, unemployment and stock market performance and matched them to presidential elections.

They went all the way back to the first re-election in 1792, when George Washington beat John Adams and won a second term as president.

The researchers found a solid connection between the stock market's direction in the three years leading up to Election Day and the election results. Gains of 20 per cent or more for the Dow nearly assured victories for sitting presidents. Drops of 10 per cent or worse got them tossed out.

Voters returned Calvin Coolidge to the White House in 1924, just as the Roaring ‘20s started roaring. They booted Herbert Hoover in 1932 while the stock market suffered through a three-year plunge.

Mood is everything

The authors of the Socionomics Institute study say everything can be traced back to the prevailing optimism or pessimism. Their organisation studies "the social mood". But how do you read the mood of a whole country?

The authors say the stock market is the best available gauge of how the country is feeling, "because investors can act swiftly to express their optimism or pessimism". Bad day? Time to sell. Things looking up? Time to buy.

"An increasingly positive social mood produces a rising stock market as well as votes for the incumbent, and an increasingly negative social mood produces a falling stock market as well as votes against the incumbent," they write.

To the authors, it's the mood that determines the election, not the stock market. The stock market is just a reliable gauge of the national temper, an incredibly accurate mood ring.

In recent successful re-election campaigns, the connection appears clear. Ronald Reagan won re-election in 1984 following the Dow's 41 per cent surge and despite an unemployment rate of 7.2 per cent. Bill Clinton was awarded a second term after the Dow gained 63 per cent in the three years leading up to Election Day.

But there are misfires. James Madison, for instance, won re-election in 1812 despite a 34 per cent drop in the market over three years. George H.W. Bush lost to Bill Clinton even though the Dow rose 51 per cent over his term in office.

Doug Wead, a presidential historian who served in the elder Bush's administration, said the stock market theory sounds suspect.

"The stock market isn't even a good indicator of the economy," he said. "You can have the stock market going up while the rich get richer and the poor get poorer."

There's also the danger of oversimplifying — relying on one number, in this case the Dow's performance, while ignoring everything from scandals and wars to third-party candidates.

In William Howard Taft's last three years in office, the Dow lost 12 per cent, and Taft lost the 1912 election to Woodrow Wilson. But if Theodore Roosevelt hadn't split from the Republicans and run under the Progressive Party banner against Taft that year, Taft might have returned to office.

It was a similar story with the first Bush in 1992. The independent candidate Ross Perot siphoned off votes from both candidates, but historians generally believe more came from Bush's Republican camp. Clinton won with just 43 per cent of the popular vote.