We are less than two months away from electing a new U.S. president, and it’s anyone’s guess who will ultimately be voted into office. When it comes to the stock market, however, it doesn’t seem to matter: Presidential Election Cycle Theory suggests that there is a predictable pattern to stock-market returns when it comes to presidential cycles, regardless of the party winner. So, based on that theory, can we draw any conclusions about how the market will finish the year (the 4th year of the cycle) and what to expect in the years to come?
Background on the theory
The theory, developed by Yale Hirsch, uses historical stock-market return observations to develop a four-year pattern that seemingly corresponds with the presidential election cycle. It is contingent upon average returns over large periods of time in proving out the existence of the following pattern:
Year 1 – The first year in office is usually characterized by weak stock-market performance and is typically the worst of the four-year cycle, because the president is just getting settled.
Year 2 – The second year is typically better than the first, but still noted for subpar performance. Hirsch points out that wars, recessions and bear markets tend to occur in the first half of the presidential term.
Year 3 – The third year, which precedes the next election, tends to post the strongest returns.
Year 4 – The uncertainty of an election year typically causes the final year of the cycle to display below-average returns.
Because the Presidential Election Cycle Theory relies on averages, and there are only a few observable periods (21 completed since 1928), there are significant performance deviations from the mean across the sample. The fact that the sample is so small makes it difficult to draw accurate conclusions, or to even conclude that any relationship exists at all.
A study completed by Deutsche Bank from 1960 through 2012 shows that, while returns in presidential election years do appear weaker on average, simply removing 2008 changes the overall analysis — revealing returns in election years to be above average. Specifically, in the period analyzed, the average election-year return is 6.5%, versus 7.9% for all years. But, when you remove the dramatically low 2008 return, the election-year average jumped to 9.1% — eclipsing the revised all-years average of 8.8%. Deutsche Bank observed in its 2016 outlook, “Absent recessions, there isn’t much of an election cycle.”
So what have we learned?
The long and the short of it is that there may be a relationship between the presidential election cycle and the stock market, but that relationship is loosely tied to long-term averages of a sample set with few observations and widely varying data points. As Deutsche Bank’s findings reveal, a single data point can skew statistics and meaningfully change an outcome. It therefore seems pretty clear that, regardless of who you vote for or what year of the presidential cycle we’re in, it’s impossible to predict how the market will perform. So vote for the candidate you trust to stand up for what you believe, and let the market do what the market does.