11/07/2012

Cloud of fiscal gloom hangs over Wall Street


Since the study of elasticity I have begun to look at things a little bit differently. There are countless times when I wonder whether or not a good or a service is relatively elastic or inelastic in regards to many things. During this semester I have also been taking an investments course and as part of our fundamental analysis we decided that the Presidential election could have a significant influence on the market as a whole and an even greater influence on our energy sector focus. The question being then; are the financial markets relatively elastic or inelastic based on a political election? We said that it had to be quite elastic based simply on the campaigns that were run and the debates that were heard.

Unfortunately, we were contested during the presentation of our beliefs. Many brought up the feeling that an election for political office would have very little, if any, influence on the financial markets. They said that there was far too much weight in other areas to believe the election could make a major play.

I can assure you that we now know that the markets can be extremely elastic to a President’s election. The markets are fully aware of what each individual believes, plans, and understands. They can then drop or climb based on the projections of a President’s role in our economy. 

4 comments:

Alexa said...

Aiden raises a good question as to the effect that presidential elections, as well as overall elections, have on the financial markets. He is correct that the markets do respond to election. I do not believe that they are not extremely elastic. However, the market will be influenced more by the laws that are actually passed by our elected officials, such as the Obama Healthcare. Even though most Americans have access to health care, there are still millions who do not. I believe that the Obama Healthcare bill will change the way in which healthcare plans are priced and bundled together.

Dominick said...

It is clear that a presidential election has a direct effect on the economy. In fact there is a theory, called the "presidential election cycle theory" (Yale Hirsch), which predicts that the stock market follows a predictable four year cycle of losses following an election, and gains leading up to an election. The current losses in the market following the most recent election would seem to support this theory. However, I think the more enriching question deals with whether the market is more or less elastic due to the political affiliation (and subsequent economic policies) of the winner. The theory claims that stocks may actually earn slightly higher returns during a four year democrat cycle (contrary to popular belief). It will be interesting to observe just how elastic the market will be to President Obama's re-election.

Clayton Parry said...

I like Aiden’s analysis on the effect of the Presidential election on Walls Street. This issue draws attention to the reality that the policies of Washington affect the financial markets. I think that regardless of which candidate was elected that the economy would be slow to recover. However, I think that the market reacted the way that it did because of a loss of optimism.
At the end of 2012 all of the “Bush era” tax cuts will expire. The current administration has stated that they plan to allow these tax cuts to expire so that additional revenue can be collected. In January 2013 the effects of “Obamacare” will begin to impact businesses and individuals alike. So, the “Cloud of fiscal gloom” is really signaling a looming storm. With tax cuts expiring many companies and individuals are faced with decisions to act before the end of 2012 on financial issues or wait indefinitely until another resolve comes along. There is no doubt that a loss in tax cuts will impact businesses, the real question remains; how great will the impact be?
Obamacare, with its financial impact upon businesses and individuals, will not help the economy turn around any faster. This means that money that could have been reinvested into the economy through consumer spending, capital investments or many other options is now earmarked for these new expenses.
The Romney campaign had promised to repel Obamacare and also provide tax incentives for economic growth. As the dust settled on election night the hopes of anything changing in the short-term diminished. The markets reactions to the election results show that a long run recovery was not what they were hoping for. Only time will tell how the agenda of the Obama administration will impact the economy and both Wall Street and Main Street are left to guess what might have been.

Dave Tufte said...

Aiden: 100/100
Alexa: 47/50 for a pluralization error.
Dominick: 47/50 for a capitalization error.
Clayton Parry: 41/50 for a spelling error, a misused word, and a possessive error.

A useful digression first: Aiden has a really good point. This comes up in macro a lot; people frequently say something like "won't this policy really help/hurt the economy". One of the things I've learned over the years is that macroeconomists have the same mental model of how the economy works as everyone else does, but that we differ about the empirical question of how elastic it is. Most of the differences between liberals and conservatives boil down to one group thinking the effect of a policy will be elastic with the other one thinking it will be inelastic. But, macroeconomists recognize that the economy is so big that it is inelastic with respect to ... just about everything.

When I extend that idea to financial markets, what I see is instead is that financial markets are very elastic in the short-run, but seem to be more inelastic in the long-run. This is the opposite of how most goods and services behave. This extends to Alexa's point that policies are more important than politicians.

I have one thing to add to Dominick's point. Actual average returns are higher under Democratic administrations. Having said that, we're not sure if there is a causal mechanism there that can justify forecasting higher returns on the future just because a Democrat won the election.

In theory, I agree with everything Clayton has said. Where I differ is a good example of what I said above: I doubt that the response to Obama's policies will be very elastic, and I tend to see a more inelastic response in the long-run.