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Election Cycles Mean More Than Just Choosing a President

Election Cycles Mean More Than Just Choosing a President
A presidential election year can change the direction of the country. It may also change the direction of the stock market. This article looks at market performance and elections since the 1920s, the beginning of the modern era of diversified market indexes.

When people think about cycles in the stock market, they tend to look at the obvious drivers of stock prices: major forces such as the state of the economy, the level of corporate profits, and conditions in global markets. But did you know that a presidential election itself can be a key pivot point in stock price trends?

Consider the average yearly performance of the stock market in the table below. After accounting for random volatility, average presidential election year performance was slightly below overall average performance.

But look at the other years in the election cycle. The first two years of presidential terms have, on average, lagged significantly. But then, in the third year, the market made up the lost ground and more.

What’s Going On?

Election years tend to have a degree of uncertainty over the future direction of the country, and the market may translate that uncertainly into some reluctance to commit on the part of investors. Then, after the direction is set, it may take some time for policy changes to assert any influence, further depressing investment demand. By the third year, clarity could return and investors could embrace the future.

Stock Market Performance and the Election Cycle1

  Calendar years: 1928 - 2014
Presidential election years: 1928 - 2014
First year after each presidential election
Second year after each presidential election
Third year after each presidential election
Average returns
11.8% 11.1%
9.2%
9.1% 18.3%
Standard deviation of the returns
20%
17% 22% 21% 20%

For Illustrative Purposes Only.

Exceptions May Be More Powerful Than the Generalities

Keep in mind that the amount of variation in annual returns is substantial, and is reflected in the high variability, measured by standard deviation. As a consequence, the chances are good that performance in any given year could end up being far different from the average for its category.

That becomes clear when looking at the extremely good and extremely bad performing years in the S&P 500 performance data set. The four best years were 1928 (44%), 1933 (53%), 1935 (60%), and 1954 (52%). The four worst years were 1931 (-41%), 1937 (-34%), 1974 (-26%), and 2008 (-37%).1

No two of the extreme up years occurred at the same point in an election cycle, neither did any two of the extreme down years. Three of the extreme years are associated with Democratic incumbents and five with Republican incumbents.

Ultimately, six of the eight extreme performance years were associated with unpredictable macroeconomic tidal waves--the Great Depression, the oil price shock (when energy prices quadrupled in a few months), and the recent financial crisis --events much bigger than any election news.

So if you are thinking of cashing in on an election year rally--or selling before an election year rout--think again. As history has shown, trying to time the market--for whatever reason--is often a loser’s game.

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