Elections, the Dollar, Stocks & the Economy

by Ashraf Laidi
Nov 3, 2008 15:51 | 9 Comments

Much has been written about the relationship between the partisan power in the White House and the performance of the stock market. Considerable amount of statistical exercise was undertaken in dissecting any the correlations and causalities involving partisan control of Congress, mid-term elections, balance of power between White House and Congress, and the impact of double term presidencies. The table below shows the performance of the dollar index, S&P500 and the general state of the US economy since the dollar became freely floated in 1971.

Here are some of the conclusions drawn from the patterns observed over the past 38 years.

Elections, the Dollar, Stocks & the Economy - Elections (Chart 1)

Dollar Performance

Out of the 38 years analyzed, there were 19 years of negative dollar performance versus 19 years of positive performance. 7 of the 19 negative years occurred when the White House and Congress were of the same party. And in all but 2 of the 19 negative dollar years, the dollar declines occurred in series of at least 2 consecutive years. 1990 and 1998 were the only negative dollar years were the decline was preceded and followed by an increase in the currency. The 1990 dollar decline occurred due to the recession caused by the Savings & Loans Crisis and soaring oil prices resulting from Iraqs invasion of Kuwait. The subsequent Fed rate cuts dragged the dollar across the board as did flight to safety. The 1998 dollar decline emerged from sharp unwinding of yen carry trades away from the dollar in the midst of a liquidity crisis in capital markets in the aftermath of collapse of Long Term Capital Management. Similarly, all but 1 of the 19 years of dollar gains occurred in at string of at least 2 consecutive years.

2005 was the only year during 1971-2008 delivering stand-alone rising performance, as a result of Feds interest rate hikes as well as the temporary reduction of taxes on U.S. multinationals repatriated profits. Such a pattern reflects the notion that foreign exchange rates move in trends, particularly a widely traded currency such as the dollar. As fundamental dynamics are built up and are accentuated by portfolio shifts, traders flows and speculative sentiment, the trend grows increasingly established.

The impact of U.S. presidential and mid-term elections on currency markets was especially prominent during the controversial 2000 presidential elections and the 2006 mid term elections. In November 2000, the already tumbling euro sustained a severe blow against the dollar at the announcement of a victory for President George W. Bush. The dollar rally emerged on the tax-cutting agenda by Republicans, which was a boon for the markets, especially after a series of tax hikes from former president Bill Clinton. Inaccurate media reporting of the 2000 election announcements erroneously declaring candidate Al Gore the winner prompted sharp but short-lived declines in the U.S. dollar. Republicans' full loss of power of the Senate and the House of Representatives in the 2006 mid-term elections sped up an already deepening sell-off in the US currency.


Stock Market

Out of the 10 years of negative stocks performance, 7 occurred during a Republican-controlled White House versus 3 under Democrat control. Of the 28 years of positive stock performance, 19 occurred during bi-partisan control between the White House and Congress. Regarding the relationship between the dollar and stocks, 7 out of the 10 negative years for stocks coincided with negative years for the dollar when 2008 is included. Fundamentally, the relationship between stocks and the dollar had been prominently positive during the early 1980s and the second half of the 1990s. In the early 1980s, the Fed's staunch anti-inflation war under the command of Paul Volcker boosted interest rates towards 20%, rendering the dollar an attractive return on foreign investors funds, while stocks recovered as inflation was dampened and oil prices retreated. In the second part of the 1990s, U.S. equities attracted persistent growth in foreign capital flows while European economies were floundered in stuttering recoveries and Japan remained in a deflationary spiral.

Economy

The criteria used to determine whether the economy fell in a recession in a given year is the number of quarters showing negative GDP growth. 1973, 1974, 1980, 1981, 1982 and 2001 each showed two quarters of negative growth, regardless of whether these were consecutive quarters. Although the economic reports are increasingly pointing to a recession in 2008, at the time of writing the official body in charge of declaring U.S. recessions has not yet done so. The National Bureau of Economic Research usually announces recessions about 2 our 3 quarters after they start. Due to this formality, 2008 is excluded from the recession count, leaving us with 8 recessions between 1971 and 2007. 1990 and 2000 were also recession years even though they had only one negative quarter. 6 of the 8 recessions occurred under a Republican Administration versus 2 occurring under the Democrats in 1980 and 2000. Regarding the sharing of power between Congress and the White House, 7 of the 8 recessions took place during a bipartisan split (1973, 1974, 1980, 1981, 1982, 1990) while 1 occurred in 1980 during dual control of the Democrats.

Dollar To Refocus on Economics

It has been widely stated that the financial markets main concern related to the election was the potential for adverse tax consequences from a Democrat-controlled White House, whereby the prevailing tax cuts will not be renewed after their 2010 expiration. Nonetheless, the risk of a Democrat victory for the market is diminished by heightened certainty that the Democrats will take control of the White House, thereby, ridding markets of the risk of the unknown. And with the US economy already mired in a recession and markets posting their biggest year-to-date decline in history, the role of politics in shoring up the economy is becoming less relevant, especially with the fiscal deficit expected to surpass the $800 billion market in 2009 regardless of politics. The fiscal imbalance is expected to breach the 7% of GDP figure regardless of whether the Bush tax cuts are phased out, or a new stimulus packaged is announced. By mid end of Q2 2009, the dollar's main preoccuaption will revert towards the structural imbalances of the currency. And like 2005, 2008 may prove to show a lone positive year.

For more on the political and economic factors shaping the dollar over the last 38 years, see Chapter 9 "Selected Topics in Foreign Exchange" of my upcoming book "Currency Trading & Intermarket Analysis".

Comments (Showing latest 9 of 9) View All Comments
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 6, 2008 17:22
Hamish,

Yes, i expect the dollar decline to be temporary later in the year coinciding with bear market rally in stocks. $1.37 is the max target for the euro during the upcoming equity bounce.

Ashraf
hamish
Canada
Posted Anonymously
11 years ago
Nov 6, 2008 16:26
Your response to Sorans caught my eye, namely leaning to a euro bounce 1.38. Is this predicated on a substancial bear market rally, long term technicals or a US economy that becomes more devastating than the Eurozone? Does a bounce also apply to the GBP?
Anyway I thought the flavour of the month are the low yielders!!
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 5, 2008 22:20
Sorans,

$1.17 is certainly viable, technically speaking. Im leaning towards a bounce near $1.38 before renewed declines towards $1.20, where a base will start to form for the next major rally.

Hamish,

As far as long term solutions are concerned, US savings must rise considerably while the dollar remains strong enough to attract foreign capital but not too strong to erode exports. Maybe the current recession will force savings higher, but it must come with increased savings from Asia.


Ashraf
hamish
Canada
Posted Anonymously
11 years ago
Nov 5, 2008 20:48
You wrote an article re: usd imbalance, now no longer on your website. What steps should the US take to correct? Intervene & revalue the $ ?
sorans
BEIJING,
Posted Anonymously
11 years ago
Nov 5, 2008 9:22
hi,Ashraf
Thank you for your articles, I hold a opinion that EURUSD will go down and maybe 1.17 is its first destination because of fundamental analysis, I think it is only a rally recently, and how do you think of EURUSD?
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 5, 2008 6:11
Jim,

The head and shoulder USDCAD formation is most prominent on the 4-hour chart. Based on my expectations for a bear market rally in stocks to as high as 1,100 in the S&P into year-end, we could see 1.1100 and a fresh recovery in USDCAD towards the right shoulder of 1.23 into early Q1 2009.

Ashraf
Jim
United States
Posted Anonymously
11 years ago
Nov 4, 2008 18:02
What do you think of the head and shoulders pattern on the USD/CAD on a 3 month 4 hour chart?
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 4, 2008 3:22
TF, dollar declines vs the yen do not have to be mimicked in EURJPY. I see the EURJPY low at near 110 yen, but there's the expectations that Eurozone rates may not have to drop as low as those in the US (Eurozone imbalances arent as large as those in the US). EURUSD seen dropping as low $1.20, but major technical support stands at $1.1740. The main theme here is that once the market volatility eases and economic deterioration remains, dollar will be a major loser and reflation trade starts to build gradually. That should also help EUR. Meanwhile, we have a 50-bp cut from the ECB this week, and a probable 75-bp cut from BoE, which will play negatively for EUR and GBP for a few more weeks.

Ashraf
TF
United States
Posted Anonymously
11 years ago
Nov 3, 2008 20:48
Hi there - this is noy exactly on topic, but sort of relates, as there is a lot of talk about a dollar 'correction' just at the time of the eletions and either now, December, or January, depending on who you believe.

People are saying hold off a dollar long position because the market is about to correct. So the key questions are for me - if the dollar/euro corrects, will the euro also get stronger against the yen ?

You forecast the yen at 79/80 in 2010 - so given the euro dollar still has further to go - the consensus being that after a correction the euro will get even weaker than it is now against the dollar, then correspondingly it must get weaker still against the yen.

The euro has lost 40% against the yen since July - how much further do you think it will go, and how would you expect that change to pan out during the next year, especially at the beginning where we exp[ect this dollar correction ?