In recent weeks, John Kerry and his supporters have claimed that his policies would stimulate the economy and that his election would be good for the stock market. Kerry supporters, for example, cite a Merrill Lynch study that shows that since 1943 the stock market returned 13.6% annually, on average, under Democratic presidents, compared with 11.7% under Republicans.

However, we do not need to speculate whether Sen. Kerry's election would provide a boost to the stock market. He has been the putative or actual nominee for many months. One can examine how his shifting political fortunes have affected the stock market itself. When Sen. Kerry's chances for election have risen in the short term has the stock market reacted positively as well? Unfortunately for the Democratic nominee, the answer is "No."

As a measure of Sen. Kerry's likelihood of election, data is used from the trading of real money future contracts based on election outcomes run by the Iowa Electronic Market. Academic research has shown that this market has been a very accurate predictor of elections--better than large-scale polling services.

In the winner-take-all market, participants can buy and sell a security that pays $1 if their candidate wins. The price of a futures contract for Sen. Kerry or President Bush can be interpreted as market participants' current collective call on the standing of the election. On Aug. 9, for example, individuals could pay 51 cents for the contract that will pay a dollar if President Bush wins. This implies that the market believes there is about a 51% probability that Bush will win. Contracts in this winner-take-all market have been trading only since June 1, while closely-related futures contracts where the prices reflects the market's expectation of the share of the total vote received by each candidate have been trading since early in the year. A greater expected vote share would suggest a greater probability of the candidate actually winning the election.

The accompanying chart plots the trading price of futures contracts for Sen. Kerry's share of votes along with the value of the S&P 500 composite index since March 3, the day after the Super Tuesday primaries. When the expected vote share rises and thus the implied probability of Sen. Kerry winning the election increases, the S&P 500 index tends to decline sharply. The pattern is consistent and significant. Given the negative response of the stock market index to increases in his electoral prospects, this suggests that a Kerry victory, or its inevitability in the run-up to the election, could cause a significant stock market decline. The correlation is apparent even when the lackluster response to Sen. Kerry and the Democratic convention depressed the value of the Kerry futures contract, and the stock market simultaneously rallied.

The stock market is affected by factors other than the upcoming election, and one might argue that the stock market is responding only to economic news and that the correlation of stock prices with the probability of Sen. Kerry's election is a mere coincidence. However, the economic news has been generally upbeat in the first half of 2004 with real GDP expanding at 3.8% clip, real business investment spending growing even faster at a 12.5% annual rate, more than one million new jobs created this year, consumer confidence generally rising, and strong growth in corporate profits. While the data have flagged a little recently, there is no obvious link between economic news releases and the implied probability of a Kerry victory in the Iowa Electronic Market futures prices.

Candidates always claim that their policies will improve economic outcomes if they are elected. Financial market developments have advanced enough that we can now evaluate what the markets think about a candidate's promises. If equity markets had a vote, it seems they would cast it for President Bush.

It has become apparent that the economy would have been weaker and the stock market lower absent President Bush's tax cuts. Research has shown that the tax cuts have provided significant support to consumer spending since 2002, and business investment spending recovered strongly after the dividend and capital gains tax cuts in 2003 lowered the after-tax cost of investing. The dividend and capital gains tax cuts, along with the improving economy, also helped boost the value of the stock market. By increasing the after-tax value of a dividend paid or a capital gain realized, the tax reduction increased the demand for equities, and pushed up prices. The S&P 500 index of stocks rose about 26% last year, and although other political and economic factors helped, the tax cuts contributed to a significant portion of this increase. Indeed, the market rallied by about one-and-a-half percentage points on the day that the House passed the 2003 tax reduction package.

Despite this record, Sen. Kerry has promised to repeal a significant portion of these tax cuts if elected, including the tax rate reductions on dividend and capital gain income. With the growth rate of the economy high but slowing somewhat, there are signs that this promise is rattling financial markets. The evidence suggests that when Sen. Kerry's political fortunes rise, the stock market tanks.

Eric M. Engen is a resident scholar at the American Enterprise Institute.