October 2016

Only one thing is certain as we approach the U.S. presidential election in early November, the Twins won’t be world champions this season. Well, maybe there’s one more thing, in January the Obamas will need to turn in their keys to the White House. Occasionally we get asked about how the presidential cycle affects the stock market or whether there’s a trend to market performance around an election. Along with many other theories and spurious happenstances, an unhealthy amount of time and resources has gone into such analysis in that eternal quest to take advantage of the stock market and strike it rich. Some of my personal favorites are that an AFC team winning the Super Bowl predicts bad stock market returns, an American-born model gracing the cover of the Sports Illustrated swimsuit issue predicts big market gains and rainfall totals in New York City are positively correlated to the stock market.

The Presidential Cycle Investment Strategy

Fairly or not, we tend to toss out analyses that tie expectations for stock market returns to unrelated events based on a statistician’s adventure in data mining. The question is whether the events are truly related or not. The answer is easier when the comparison is between the outcome of a sporting event and the capital markets, but is it quite so easy when the comparison is between politics in the world’s largest economy and the markets?

First let’s look at the data. Using the S&P 500 Index as our proxy for the stock market, here’s a summary of market returns back to 1936 during the four years of the U.S. presidential cycle.

Graph 1

You don’t need a doctorate in statistics to recognize why the phenomenon of investing along with the presidential cycle has drawn attention. So if everyone knows about this relationship, why doesn’t everyone exploit it? You’ll be glad that we didn’t! Let’s look at the last two instances of the supposedly “best” and “worst” years to invest in stocks according to the presidential cycle investment strategy.

The last two post-election years were 2009 and 2013. These should have been years in which you would expect depressed market results. Recovering from the market crisis of 2008, the S&P 500 Index surged over 26 percent in 2009 as the Federal Reserve stepped in to stimulate capital markets and backstop the economy¹. Four years later, markets surged again. In 2013, the market was up over 32 percent as corporate profits soared and the markets welcomed the expectation of continued stimulative, or “dovish”, monetary policy from the incoming Chair of the Federal Reserve, Janet Yellen¹.

Now to the last two pre-election years, or those that should have been very lucrative for stock investors. In 2011, the market ended the year nearly unchanged from where it began the year. Remarkably, if not for dividends the market would have started and ended the year within four-hundredths of a point apart. The markets were weighed down by a growing economic and debt crisis in Europe. In 2015, markets again ended nearly unchanged, rising only 1.4 percent¹. Fear of rising interest rates in the U.S. and slowing growth in emerging markets contributed to the lackluster returns.

Notice that none of the explanations for why markets were up, down or flat, good or bad had anything to do with the political rhetoric of the sitting president or the heir apparent.

One could argue that I’m being as biased by highlighting the last two cycles as the average returns are in hiding the variation of the returns behind those averages. This point may be valid. In fact, in pre-election years there has only been one year in which the market didn’t end higher from where it started. That was 1939 when the market fell a whopping 0.4 percent. Conversely, in post-election years markets have retreated 45 percent of the time².

Is This Strategy Legitimate?

The question remains after forcing you to wade through all of those numbers with me, is this strategy legitimate or not? In our opinion, there may be a relationship between the presidential cycle and stock market performance. The problem is that there are too many extraneous factors at play to have any confidence that it will consistently lead to outperformance as an investment strategy. Globalization and increased central bank intervention are high on my list of extraneous factors that could influence markets at different and unpredictable times throughout a presidential term.

Sadly, we’re left with no golden goose – rest in peace Gene Wilder. With that said, the Denver Broncos (AFC) won Super Bowl 50, the Farmer’s Almanac predicts below average precipitation in the Big Apple over the next several months, and for the first time in history Sports Illustrated published its swimsuit issue with three separate models…all American-born. That’s two indicators predicting poor market returns and one indicator forecasting good market returns…err maybe it should be three in this case!