The U.S. presidential election cycle theory of the stock market says that the market moves based on the year of the president's term. Is there any proof?
Next January 20, a new U.S. president will take the oath of office. Are there implications for the stock market?
The presidential election cycle theory claims that the market follows a pattern linked to the president’s year in office. The theory contends that the first year of a new president’s term is the weakest for U.S. stocks, with improvement coming over the following years. That would seem to signal odds for a challenging market in 2017, with stronger performance from 2018 through 2020.
Does evidence back the theory? It depends. The S&P 500 Index (SPX) did fall in 1969, 1977, and 1981, the first years of the first terms for Presidents Richard Nixon, Jimmy Carter, and Ronald Reagan, respectively. In each of those administrations, the market recovered from first-year jitters and strung together some positive results as the terms continued.
Why would it work this way? Perhaps, analysts say, because of uncertainty about a new president’s policies as he (or she) takes office, followed by growing confidence in later years of the administration.
But arguably, the theory has been pretty miserable lately at predicting the market’s first year of performance under a new president.
“The presidential cycle hasn’t really followed form over the last few years,” said David Settle, curriculum development manager at Investools®. “We’ve had good years in years we weren’t supposed to.”
For instance, in 2009, the first year of President Barack Obama’s first term, the SPX rose 23.45%. In 1993, the first year of President Bill Clinton’s first term, the SPX rose nearly 10%. Stocks also climbed in 1989 under President George H.W. Bush in his first term. If the theory held true, those should have been bad years for stocks.
Since 1944, the market has averaged a 6.2% rise in the first year of a new president’s term, according to S&P Global Market Intelligence. That isn’t as good as the average annual 8.6% market rise over the time period, but it’s certainly not too shabby, and it’s not the worst average year in the presidential cycle.
So if the stock market has recently done well in the first year of a president’s first term, raising uncertainty about that old theory, is there any long-term pattern that can be deduced from the presidential election cycle that’s held up into modern times?
The theory seems to offer more value when it comes to the latter years of a president’s first term, as markets often performed best in years three and four. The worst year of a first term tended be the second year, not the first, with growth of just 0.5% in the years since 1944. The third year of a new president’s term has the best record, with 17.5% growth in the SPX, while the fourth year came in at 10.2%.
What if a president is reelected? Did the market suffer during the first year of that term? No. In fact, first years of second terms tended to be better than average, with the SPX rising 9.8%. The last year of the second term of a sitting president (the one we’re in now, by the way) was on average the very worst year of the eight-year presidential cycle, with an average SPX loss of 3.3%.
"In general, Wall Street hates uncertainty,” said Sam Stovall, U.S. equity strategist at S&P Global, in a recent note to investors. "Second-term presidential elections generate leadership uncertainty, since both candidates are unknown quantities. Even so, the S&P 500 did quite well in some second-term election years, rising 11.8% in 1952, 7.7% in 1968, and 12.4% in 1988. Yet in 2000 (-10.1%) and 2008 (-38.5%), the S&P 500’s returns probably had more to do with the bear markets that were already in place than concern over who was running for president."
If a presidential election doesn’t predict the stock market, can it work the other way? Does the market’s performance between now and November 8 influence, if at all, who gets elected?
The answer is an equivocal yes. There is a definite long-term pattern in the SPX’s July 31 to October 31 performance during election years and who gets elected. When August-through-October stock market performance slumps during an election year, a new party tends to win the White House that November. When the market does well during that time period, the sitting party often keeps the Oval Office. Maybe voters reward or punish politicians for stock market performance immediately before the election, although there are certainly far more factors at work.
“More times than not, S&P 500 price returns identified whether the incumbent president, or his party, was reelected or replaced,” Stovall said. That’s been the case in 82% of election years since 1944.
For instance, in 2012, when the SPX rose 2.4% during the August-through-October stretch, incumbent President Obama won another term. Obama won his first term, switching the White House from Republican to Democrat control, in 2008 after the SPX plummeted 23.6% between August and October.
That same pattern appeared in 2004, 2000, 1996, 1992, 1988, and 1984. The last time the sitting party failed to keep the White House despite a positive stock market was Reagan over Carter in 1980, but that election featured a strong third-party candidate, making it atypical.
That’s when this year comes into play. Every election is unique, but arguably 2016 could shape up as a true outlier. That’s due partly to the somewhat unconventional campaign being run by Donald Trump, and the fact that Trump, unlike any major party nominee since Dwight Eisenhower in 1952, has never held elective office. Also, Hillary Clinton is the first woman to be a major party nominee. Does all that mean the market’s long stretch of predictive value is over?
“Trump is a walking uncertainty,” Settle said. “You don’t know what he’ll say or do. He’s not the typical candidate of either party.”
That makes 2016 a rather odd election, so keep an eye on this number: 2173.6. That’s where the SPX closed on July 29, the last trading day of the month. Will it be higher or lower on October 31? We shall see, and maybe, just maybe, it could have an impact on November 8.
FIGURE 1: ELECTION PATTERN?
The S&P 500 (SPX), plotted for the last 20 years on the TD Ameritrade thinkorswim® platform, reveals a pattern in which performance between July 31 and October 31 correlates with presidential election results. When the market rises during those months before an election, the incumbent party tends to win. When it falls, the incumbent party tends to lose. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.
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