The stock market proved to be a poor predictor of this year’s U.S. presidential election, and it’s important to explore why.
In several recent columns, I reported on a simple model that correlated the incumbent political party’s chances of retaining the White House with the Dow Jones Industrial Average’s DJIA year-to-date return. Right before the election, that model was giving U.S. Vice President Kamala Harris, the Democratic candidate, a strong 70% chance of beating former U.S. President Donald Trump.
When a model fails, investors should use the occasion to explore what can be learned. Was this just one of those times when a model turns out to be wrong — something that inevitably happens sooner or later because no model works all the time? Or have there been more fundamental changes in the U.S. economy and the financial markets that make the model less useful?
With the election now over, my sense is that model’s breakdown has to do with the growing disconnect between Wall Street and the broader economy — what many call the Wall Street-Main Street disconnect. The reason that my simple model worked so well in decades past is that voters tend to vote their pocketbooks and the Dow used to be a decent barometer of overall economic health. This may no longer be true, or at least as true as it once was.
To show this, I analyzed quarterly changes in U.S. GDP with quarterly changes in the S&P 500’s SPX earnings per share (EPS) back to 1947. Specifically, I calculated the trailing 20-year correlation coefficient of these quarterly changes. (That coefficient ranges from a theoretical maximum of 100%, which would indicate that GDP and EPS move in perfect lockstep with each other, to a theoretical minimum of minus 100%, which would mean that the two move inversely to each other. A coefficient of zero would mean that the two have no detectable relationship with each other.)
The chart above plots what I found. Except for a brief blip in the wake of the 2008-09 global financial crisis, when both the GDP and EPS fell in unison, the correlation between the economy and the stock market has been steadily declining for several decades and is currently only marginally higher than zero.
In 1992, for example, when Democratic strategist James Carville coined the phrase “It’s the economy, stupid,” the trailing 20-year correlation stood at close to 40%. The latest reading is just 15%.
This decline helps us understand why a strong stock market this year did not translate to a better showing for Kamala Harris, the candidate of the incumbent political party. Even as the stock market has soared, many Americans struggle with both personal and family finances.
The implications going forward are profound; economic forecasting may not be as useful in the future. Financial analysts may need to focus more on the idiosyncrasies of particular companies than macroeconomic cycles. This point was made recently by Vincent Deluard, director of global macro strategy at investment firm StoneX. He argued that “investors spend far too much time worrying about the next recession. Economic growth is just one small driver of stock prices. Margins and multiples matter a lot more to stock prices.”
To put Deluard’s point another way, the dollar value of a company’s sales it’s less important than the percentage of its sales that make it to the bottom line and the price/earnings multiple that investors are willing to place on that profit. This isn’t to say that forecasting profit margins or P/E multiples is easier than forecasting the economy. But once you realize how small a role economic growth is playing, you can focus on these more consequential factors.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at
More: What the stock market can expect if Republicans control the White House, Senate and House
Also read: Stock-market bulls rely on 2016 ‘Trump trade’ playbook — but 2024 is very different
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