Obama and the Stock market

Glenn Reynolds links to a post with a graph showing the correlation between the betting odds that Obama will win and the fall of the Stock Market. He correctly points out that correlation is not causation, but he does not elaborate. I presume that he is suspicious of the suggestion that the increase in the expectation that Obama will win is causing the stock market to fall. However, it is possible that the graph is revealing another causal relationship (i.e., the fall in the stock market is increasing the expectation that Obama will win).

On the same topic, James Pethokousis has an article with a title asking is Obama depressing the market. However, his first line in the article calls such a suggestion "an absolute cheap shot".

IMO, the relationship displayed in the graph is the cause of two correlations and two causal effects, which are:

• The economy has gone into a tailspin. This creates a correlation between the expectation that Obama will win and the fall in the stock market. Investors in the stock market are selling because they feel the economy is in bad shape, and going to get worse. Voters vote their pocketbook (i.e., if the economy is bad, the incumbent's party is punished in the election) is a known phenomenon. If the past is a guide, Obama benefits from this phenomenon. Hence, the expected value of Obama contracts is increasing.
• The fall in the stock market is the most visible indicator of the state of the economy. As the stock market has fallen, the state of the economy becomes apparent to many additional voters, which increases the probability of voters voting their pocketbook. This has a causal effect of further increasing the value of Obama contracts.
• Investor's buy based upon how they feel future laws and regulations will affect the market. As the phenomenon of voters voting their pocketbook also increases the probability that Democratic Party will increase their control in Congress, this creates an incentive to sell stocks that will be adversely affected by the Democratic Party control. Any decrease in the stock market due to this effect would be a result of correlation rather than causation (i.e, in regards to the original graph).
• If I were an investor, I would much rather have a President who respects free markets, and will try to reduce the cost to production by cutting taxes and regulations, rather than one who will increase the cost of production by enacting new laws and taxes, and who will impose subsidies that benefit non producing members of society. In this sense, if I truly felt that Obama was more likely to win the next election, I would be selling across the board. I suspect that their a quite a few investors who feel the same way. So, I suspect that yes, the rise in the expectation will be the next President is having a small but causal effect on the decrease in the Stock Market.