There is a remarkable op-ed in the Wall Street Journal today. It’s called “Kerry Up, Markets Down.” (You can view it at http://www.aei.org/news/filter.,newsID.21046/news_detail.asp. For some reason, powerblogs is not letting me insert links.) In it, the author notes that there has been an inverse relationship between the S&P 500 and the value of a “Kerry wins” futures contract in the Iowa Electronic Market. In other words, a greater perceived likelihood of Kerry winning has been associated with lower prices on the stock market. On this basis, the author confidently states that “Financial market developments have advanced enough that we can now evaluate what the markets think about a candidates promises. If equity markets had a vote, it seems they would cast it for President Bush.”
At the outset, it bears noting that this could be coincidence. The author acknowledges that possibility and then dismisses it, relying on his contention that “the economic news has been generally upbeat in the first half of 2004.” Holding aside the debatable characterization of the economic news as upbeat, doesn’t market theory emphasize that traders are very good at predicting such developments, so that we should have expected stock prices to incorporate the expected good news months ago?
But the real problem is that if there is a strong correlation here (as seems plausible), an obvious hypothesis is that the author has the causation backwards: when the markets decline, savvy political traders judge that Kerry has a better chance of winning. The markets, after all, both reflect economic activity — and expectations — and directly affect the wealth of millions of voters. Decreases in stock prices make people feel less wealthy and send a signal that the economy may not be doing so well. It seems rather obvious that both the reduction in wealth and the signal would tend to hurt the party in power, and help a challenger.
This hypothesis seems so obvious that I feel silly explicating it at any length. Yet the op-ed ignores it entirely.
The op-ed’s hypothesis is also possible. The same is true of the hypothesis that the markets decline for non-Kerry reasons but recognize that this helps Kerry and so decline more; but the same is also true of the hypothesis that the markets decline for non-Kerry reasons but recognize that this helps Kerry and so decline less (i.e., that the decline would be greater if it did not help Kerry).
I recognize, of course, that one is not obliged to respond to every counter-argument in an op-ed. But the possibility that the market’s decline is causing Kerry to rise, and not the reverse, seems sufficiently obvious that the failure to consider it makes the op-ed a bit silly. Or maybe this a witty parody — the author is actually a Kerry supporter who wrote an op-ed that was such an unpersuasive partisan hack job that it would discredit the intelligence and good faith of Kerry’s opponents. Those Kerry supporters sure are clever — and subtle.