Capitalist Nexus

The Palin Barracuda Index (PBI) closed the week at 101.4, up 1.9 points from 9/5.

The purpose of this index is to measure how the market assesses the likely change in tax policy in the upcoming presidential election.  Increases in the index indicate the market feels a  McCain victory is more likely, while decreases indicate an increased probability of an Obama victory.  The tension between these candidates, boils down to  keeping capital gains taxes low, and trying to control and/or reduce the size of government versus increasing capital gains taxes and expanding government’s role in the economy.  Given the contrasts between McCain and Obama in these areas, examining the relative returns of growth and value stocks seems like a natural way to quantify the market’s view as to how the race is progressing.  For a review of how taxes and inflation affect growth and value stocks look here.  For a specific look at how taxes affect growth and value stocks look here.

The increase in the PBI this week is consistent with a favorable week for the McCain campaign.

1. Barack Obama spent a significant part of the week addressing Sarah Palin rather than John McCain.

2. Barack Obama has shifted his campaign strategy to pursue a more negative and attacking tone against John McCain.

3. Sarah Palin passed an ongoing “gotcha” interview with Charles Gibson.

Since introducing the Palin Barracuda Index, I have received many emails to clarify how to use this tool.  So here are a few thoughts.

1. This is not a predictive model that maps neatly into probabilities.  In other words, if the index reads 110 a week before the election we cannot say McCain will win with 80% probability, 70% probability, or any specific probability.  We can interpret such a value as that the market is more confident about McCain winning relative to when I launched the index on 9/4/08.

2. The index does not have anything to do with Sarah Palin affecting growth stocks after the election.  I created this index, as when Sara Palin was introduced to the American public she seemed to be a genuine game changer regarding the election’s outcome.  Because McCain’s platform to keep capital gains taxes low and control government spending is more favorable for growth stocks relative to value stocks, I thought this index would be a relevant way to get an independent look at how the election is unfolding.

3. Why not just rely on Intrade or other “predictive markets”?.  While those markets are interesting, they tend to be thinly traded, and seem to reflect prices that sometimes reflect emotion rather than fact.  For example, Ron Paul tended to trade at unreasonably high prices, most likely caused by his avid followers wishing to keep him in the news.  Therefore while those markets are interesting, using the depth of the stock market provides a much more robust perspective.

4. The relative returns between growth and value stocks are affected by more than just potential changes in tax rates.  I agree that many issues affect the relative attractiveness of growth and value stocks, but given the short time period between when I launched the index and the election, I believe the most relevant issue affecting stocks will be how these tax and governmental philosophy issues get resolved.  During this time there will be events and issues that come up and add noise to our interpretation, but in general I think the market will give us a clear direction as to who will win by voting with billions of dollars between growth and value stocks.

Over the next week I will try to provide some historical perspective on the PBI to quantify what consitutes a significant move over a particular period of time.  I will also try to take a deeper look at its construction, to try and prevent any significant sector concentrations from affecting the returns in the coming weeks.

The Palin Barracuda Index dropped 0.8 today to close at 99.4.

Though polls were favorable to McCain/Palin today, the market seemed to put tax issues in the backseat instead focusing on short-term safety as unemployment numbers were horrible relative to expectations.  Obama wasted no time working hard to remind voters how good times were under Clinton and Democratic leadership.

I will examine Obama policy illusions regarding the Clinton days soon, but needless to say it reminds me of a Las Vegas contortionist act.

I discussed here how capital gains taxes affect stock prices, and here how this effect is magnified for growth stocks relative to value stocks.  Essentially, as capital gains taxes increase, growth stock prices will fall faster than value stocks  prices, and conversely as capital gains taxes decrease, growth stocks will appreciate faster than value stocks.  As a result, the relative returns of growth versus value stocks provide insight into the market’s expected likelihood of changes in capital gains taxes, among other things.  Given the short time span before the presidential election, and the very different tax positions taken by the two candidates, the behavior of growth versus value stocks will give us the market’s prediction regarding the election’s likely winner.

Should an Obama victory become more likely, value stocks will tend to outperform growth stocks.  In fact, over the past week, as the Democrats had a great convention, and media piled on Sarah Palin, value stocks outperformed growth stock, reflecting the favorable environment for a Obama victory.  This last week, however,  stood in contrast to what has been a favorable summer for McCain, which tended to explain why growth stocks trumped value during much of this time.

Last night, Sarah Palin’s speech may have fundamentally changed the presidential race, and in her honor I created the Palin Barracuda Index.  The Palin Barracuda Index (PBI) measures the return difference between growth and value stocks, giving us an insight into which direction the market is leaning at a point in time.

I launched the PBI with a value of 100 on September 3, 2008.  Increases in the index indicate an election environment favorable for McCain and his intention to keep Capital Gains taxes at their current levels.  Decreases in the index indicate an environment favorable for Obama and his tax raising philosophy.

The higher the index value, over the next couple months, the more likely the market anticipates a McCain victory.  The lower the index value, the more likely the market anticipates an Obama win.  I will provide ongoing commentary to discuss significant changes to the index, and add graphical trends as more data becomes available to visually track how market sentiment about his presidential has changed over time.

Today the Palin Barracuda Index closed at 100.3, up 0.3.  Good news for economic freedom!

I will update the PBI regularly throughout the election.