- Some historians and economists believe market performance generally correlates with the four-year US presidential election cycle.
- While there is some connection, we do not believe it’s enough on which to base a sound investment strategy.
- Although the relationship between politics and markets is interesting, investors should focus on long-term goals.
A four-year cycle (and sometimes eight)
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 the late 1960s. According to historian Yale Hirsch, founder of the Stock Trader’s Almanac, this theory states that US stock market performance follows a predictable four-year pattern that correlates with the American presidential cycle.1
Until the twenty-first century, this theory held mostly true. However, the S&P 500 Index (an unmanaged, market-weighted index that consists of 500 of the largest publicly-traded US companies and is considered representative of the broad US stock market) skyrocketed during the first year of the George W. Bush, Barack Obama and Donald Trump presidencies (Download the full commentary to view exhibit).
First is (historically) the worst
Until the first year of President George W. Bush’s first term, investors tended to earn the smallest amount of stock market gains in the year immediately following a presidential election.
Yes, there is often a honeymoon period of optimism among Americans about new leadership that boosts the market. 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.
Second is better, third is best
During Year Two of a presidency, the economy has tended to level out. Year Three of a president’s term has generally been the best, performance-wise, for the US stock market. Researchers believe this is because the incumbent, thinking ahead to re-election, often introduces measures designed to stimulate the economy — to which the market tends to respond favourably. Since 1928, the third year following a election year has been positive for US stocks about 82% of the time.2
Fourth is fine…eighth, not so much
Market performance diverges in the fourth year of a presidential term. Incumbents are often re-elected, which creates less panic in the market compared to Year Eight of a two-term presidency, when 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 year of a two-term presidency.3
More compelling may be the US stock 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 31 July and 31 October leading up to Election Day.4 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. US lawmakers, not the President, generally have more direct impact on stock-market performance.
According to Ned Davis Research, a split Congress has the biggest negative influence on US stocks, owing perhaps to term-length differences between the House and the Senate.5 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.
Don’t be bullied by the cycle
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 affect the US 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 long-term goals and resist the urge to react.
5 Clissord, E. & Nguyen, T. (July 14, 2020). 2020 Election Handbook. Ned Davis Research. Issue SP20200714.
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