What is the presidential election cycle theory?
The theory of the presidential election cycle, developed by Stock Trader’s Almanac founder Yale Hirsch, postulates that stock market returns follow a predictable pattern each time a new US president is elected. According to this theory, the United States stock markets the weakest performance in the first year, then recovers, peaking in the third year, before falling in the fourth and final year of the presidential term, after which the cycle begins again with the next presidential election.
Key points to remember
- The theory of the electoral cycle is based on the idea that a change in presidential priorities is a primary influence on the stock market.
- The theory suggests that markets work best in the second half of a presidential term when the incumbent is trying to stimulate the economy to seek re-election.
- Data from the past few decades appear to support the idea of a stock spike in the second half of an election cycle, although the limited sample size makes it difficult to draw firm conclusions.
Understanding the Presidential Election Cycle Theory
Fellowship researcher Yale Hirsch published the first edition of the Stock Trader’s Almanac in 1967. The guide has become a popular tool for day traders and fund managers hoping to maximize their returns by time the market. The almanac introduced a number of influential theories, including the “Santa Gathering” in December and the “Best Six Months” hypothesis, according to which stock prices tend to fall during summer and winter. fall.
Hirsch’s aphorisms also included the belief that the four-year presidential election cycle is a key indicator of stock market performance. Using data going back decades, the Wall Street The historian postulated that the first year or two of a presidential term coincided with the weakest stock market performance.
According to Hirsch’s theory, after entering the Oval Office, the Chief Executive tends to work on his deepest policy proposals and to satisfy the vested interests of those who got him elected.
However, as the next election approaches, the model suggests that presidents focus on strengthening the economy in order to be re-elected. As a result, the main stock stock indices are more likely to appreciate in value. According to the theory, the results are fairly consistent, regardless of the political orientation of the president.
Presidential Election Cycle Theory versus Historical Market Performance
A large number of factors can affect the performance of the stock market in any given year, some of which have nothing to do with the President or Congress. However, data from the past few decades suggests that there may in fact be an upward trend in stock prices as the chief executive gets closer to another election.
In 2016, Lee Bohl, a Charles Schwab researcher, analyzed market data between 1933 and 2015 and found that in general, the third year of the presidency overlapped with the strongest market gains. The S&P500a fairly broad stock index, posted the following average Return in each year of the presidential cycle since 1933:
- Year after election: +6.7%
- Second year: +5.8%
- Third year: +16.3%
- Fourth year: +6.7%
Since 1930, the average annual rate of return on the S&P 500 has been 6.34%, adjusted for inflation. So, while the numbers don’t show a big drop in the first and second year, as Hirsch predicted, there does appear to be an increase in the third year.
However, averages alone do not tell us whether a theory has merit; it is also a question of reliability from one electoral cycle to the next. Between 1933 and 2019, the stock market recorded gains in 70% of calendar years. But in the third year of the presidential election cycle, the S&P 500 has seen an annual increase 82% of the time, showing notable consistency. By comparison, the market gained 59% of the time in the first two and two years of the presidency.
Over the past 80+ years, the third year of the presidency has seen an average stock market gain of more than 16%, although the limited number of election cycles makes it difficult to draw reliable conclusions about the theory.
Donald Trump’s presidency was a notable exception to the first-year stock market crash predicted by the theory. The Republican actively sued an individual and a company income tax breakout that was breached at the end of 2017, fueling a rally that saw the S&P 500 climb 19.4%. His second year in office saw the index plunge 6.2%. But again, the third year marked a particularly strong moment for actionswhile the S&P jumped 28.9%.
Limits of the presidential election cycle theory
Overall, the predictive power of presidential election cycle theory has been mixed. Although the average market returns in the first and two years have been slightly slow overall, as suggested by Hirsch, the direction of stock prices has not been consistent from cycle to cycle. The uptrend of the third year proved to be more reliable, with average gains far exceeding those of other years. Additionally, about 82% of all cycles since 1933 have seen a market gain in the year following the midterm elections.
Whether investors can feel comfortable timing the market based on Hirsch’s guess, however, remains debatable. Since presidential elections only happen once every four years in the United States, there simply isn’t a large enough sample of data to draw conclusions. The reality is that there have only been 23 elections since 1933.
And even if two variables are correlated – in this case, the election cycle and market performance – that does not mean that there is a causal link. It could be that the markets tend to rise in the third year of a presidency, but not because of any new prioritization by the White House team.
The theory rests on an inflated estimate of presidential power. In any given year, the stock market can be influenced by a number of factors that have little or nothing to do with the leader. The presidential grip on the economy is also limited by its increasingly global nature. Political events or natural disasters, even on other continents, could affect markets in the United States. Like, of course, a global pandemic.
In a 2019 interview with The Wall Street JournalJeffrey Hirsch, son of the architect of the presidential election cycle theory and current editor of the Stock Trader’s Almanac, indicated that the model still has merit, especially with regard to the third year of the mandate. “You have a president campaigning from a bullying pulpit, pushing to stay in power, and that tends to drive the market up,” he told the newspaper.
However, in the same interview, Hirsch acknowledged that the theory is also sensitive to single events in a given cycle that can influence investor sentiment. He noted that the composition of the Senate and House of Representatives, for example, can also be an important determinant of market movements. “You don’t want to jump to conclusions when there aren’t a lot of data points,” he told the Log.
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