Election years have traditionally been market-friendly, but that doesn’t mean you should base your portfolio decisions on politics. It seems that the election cycle starts earlier with each election and this year is no exception as the 2016 race has already begun.
Those with a close eye on the stock market are always on the lookout for correlations that might help them take advantage of the next market cycle. With an election year approaching – a time that has boded well historically for equities – you may question whether or not political races should affect your investment strategy. A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a new U.S. president. According to this theory, after the first year, the market improves until the cycle begins again with the next presidential election.
Pre-election years in particular have produced an average annual return of 11.3% since 1900 (Source Ned Davis Research). Since 1940 the Dow has risen in 100% of third years, gaining an average of 22.3%. That contrasts with an average gain of just 3.1% during all non-third years since 1940. In years one, two, and four, the market has risen 57% of the time (source Barrons 10/2/14) .
What about third years of a president’s second term, as is the case today? It certainly seems plausible that the Presidential Election Year Cycle would be weaker during second terms, since re-election is not an option. But there is no historical support for this suspicion, since — as the table shows — the market in the past has been slightly stronger during third years of second terms than in first terms (source Barrons 10/2/14))
Dow Jones Industrial Average
|Since 1896||Since 1940|
|Average Gain||% of Time Up||Average Gain||% of Time Up|
|All 3rd years||15.0%||82%||22.3%||100%|
|All non-3rd years||4.4%||58%||3.1%||57%|
|All 3rd years following 2nd years in which market gained||18.2%||86%||22.1%||100%|
|All 3rd years following 2nd years in which market fell||11.7%||79%||22.4%||100%|
|All 3rd years of second terms||18.4%||90%||24.6%||100%|
|All 3rd years of first terms||13.1%||78%||21.1%||100%|
|All second-term 3rd years that followed 2nd years in which market gained||18.7%||83%||28.2%||100%|
|All second-term 3rd years that followed 2nd years in which market fell||17.8%||100%||21.1%||100%|
Numerous studies show that the stock market has tended to perform well in the two years leading up to a presidential election. While substantial evidence suggests that the market does go up more often than not in election and pre-election years, it is my belief that relying on this trend is not a good way for long-term investors to pursue their goals.
Though the data appears to demonstrate a reasonable correlation between the election cycle and the market’s performance, this does not necessarily prove that one event has always caused the other. It could be coincidence. Nevertheless, various theories have attempted to explain why the stock market might be sensitive to the political seasons.
One popular theory suggests that the incumbent party leverages economic policies to give the market a slight nudge just before election time, then allows the market to appropriately correct itself once elections are over. Another theory proposes that investor confidence tends to rise based on the lofty promises of candidates vying for office, then tapers off as some of those promises fall by the wayside.
Regardless of which theory, if any, you choose to believe there are a myriad of factors that affect the markets and isolated factors such as political elections never explain the whole story.
It’s also important to note that there have been a few major exceptions to this trend in the past – 1987, a pre-election year, saw the worst market crash in U.S. history and in 2008 we saw a decline of almost 38%.
While it may be academically interesting to look at election cycles and market performance is it is clear that investment decisions shouldn’t be based solely on any theory. Investment decisions should be based on sound fundamentals, and, most important, your individual goals and circumstances. As always please contact us with questions or to discuss you personal wealth management vision and objectives.
The Dow Jones Industrial Average is an unmanaged index of 30 widely held U.S. companies commonly used to measure stock market performance. Investors cannot invest directly in the Dow Jones Industrial Average. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Randy Carver and not necessarily those of RJFS or Raymond James. Past performance is no guarantee of future results. Index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete.