The graph shows the monthly U.S. corporate credit spread of Baa-rated bonds minus AAA-rated bonds. The bond yields are calculated as Moody’s seasoned corporate bond yields with maturities as close as possible to 30 years. Meaning? When the likelihood of default increases, the bond yield increases. Baa firms are more likely to default than AAA firms. When good economic conditions are expected, investors expect both Baa and AAA firms not to default, and thus the credit spread is small. When poor economic conditions are expected, the likelihood of default of all firms increases, more so for Baa firms. As such, investors demand greater return (yield) and so we see the credit spread increase. A high spread generally indicates(expected) poor economic conditions.
A data file is here.
The Tippie School at U. of Iowa run electronic markets to trade futures contracts that represent expected outcomes of real events. 2012 presidential race contracts were used to track the expected election winner. A student pointed out that the Republican victory contract was negatively correlated (=-.83) with the S&P close, and incorrectly concluded that the markets rose in anticipation of the Democrat winner. Correlation is not causation. Both data series have secular trends; it is incorrect to analyze time series data like this. Without going too far into technical details, you must instead analyze first differences (changes in prices) or returns. As it turns out, even with a large sample (18 month of daily trading), there is no significant correlation between the likelihood of either party winning and the S&P500 close using proper methods. Furthermore, lags (e.g., the change in Republican likelihood today affects the S&P tomorrow) are insignificant. That is not to say there is no correlation, but rather one cannot conclude that the correlation is different from zero. While it is likely the stock markets have a party preference, we cannot find it in these data.