Election year is heating up. One common campaign promise from both parties is a soaring stock market. But can any candidate really guarantee that, if they’re elected, voters will see an improvement in their portfolios?
Economists and historians alike have attempted to answer this since the mid-twentieth century, leading to the development of the Presidential Election Cycle Theory in 1968. According to stock market historian Yale Hirsch, founder of the Stock Trader’s Almanac, U.S. stock market performance follows a rather predictable four-year pattern that correlates with the American presidential cycle.
First is the worst
Despite campaign promises that indicate otherwise, Investors tend to earn the smallest amount of stock- market gains in the year immediately following a presidential election. Yes, there may be a honeymoon period of optimism among Americans about new leadership that could boost returns.
But policymakers under a new presidency may also begin to feel less restrained about introducing programs—some of which could be unpopular or restrictive—such as a tax hike or increased government spending. This may negatively impact business profits and consumers, causing the market to slump.
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Second is better, third is best
During Year Two of a presidency, the economy tends to level out, and in Year Three, the market typically improves further. Researchers believe this is because the incumbent, thinking ahead to re-election, introduces measures designed to stimulate the economy—which produces a favorable result for the market. Since 1928, the third year following an election year has been positive for U.S. stocks about 82% of the time.
Fourth is fine…eighth, not so much
Market performance diverges in the fourth year of a presidential term. Incumbents are usually re-elected, which creates less panic in the market compared to Year Eight of a two-term presidency. In the final year of a two-term presidency, markets tend to fall, as investors despise uncertainty. Data from S&P Global Market Intelligence shows that since 1944, the S&P 500 Index has only risen 50% of time during the final years of a two-term presidency.
Is the market a crystal ball?
More compelling may be the market’s influence on the outcome of an election. According to Presidential Election Cycle Theory, the incumbent president has won 87% of the time (and every election since 1984) when the S&P 500 Index has advanced between July 31 and October 31 leading up to Election Day. Conversely, when the Index declined during the same period, the challenger unseated the incumbent.
Congress has the most clout
No matter who claims victory in the presidential election, their influence on the stock market is generally limited. The lawmakers in Congress have the most direct impact on stock-market performance.
According to Ned Davis Research, a split Congress has the biggest negative influence on U.S. stocks, owing perhaps to term-length differences between the House and the Senate. House representatives are re-elected every two years, while senators are re-elected every six. If one political party’s approval rating drops amid economic policy missteps, it does not necessarily mean that it will lose both the House and the Senate simultaneously.
Stay the course
It’s easy to get caught up in every little market move. But for long-term investors, a four-year cycle—volatile or otherwise—should not have a lasting effect.
Theories about how the presidential cycle affects the stock market are just that—best educated guesses. Even academicians and economists don’t always get it right. No matter what phase of the presidential cycle we happen to be in—or which candidate wins the election—stay focused on your long-term goals and resist the urge to react.
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