Will the US election cycle theory hold up?

The final years of a presidential term—the third and fourth—have frequently been blessed by prosperity and bull markets. This has been especially true of the third year.


US presidential election cycle theory holds that the final years of a president’s term are frequently blessed by prosperity and bull markets as the party in power pursues re-election.

Amid all the worries and concerns about the global economy and corporate profits, some market pundits predict that share prices will finish the year higher than they were at the start of 2020 (see below). Usually such pundits rely on economic and corporate-profit data to make their predictions. But a popular stock-market theory also suggests that 2020 will be an up year—at least for the US market, that is. We’re talking about the presidential election cycle theory.

At first glance this theory might seem like one of those silly indicators such as the Super Bowl Indicator (https://www.adviceforinvestors.com/tag/super_bowl_indicator/). But there’s data to suggest the presidential election cycle indicator has some substance to it. And it’s arguable that its success can at least be attributed to rational explanations.

The indicator goes like this: During the first two years of a president’s term in office, markets tend to be relatively weak. Presidents spend less time on the economy and more time on pursuing their favourite policy proposals and satisfying the special interest groups who helped get them elected.

Run-up to the election is good for stocks

The final years of a presidential term—the third and fourth—have frequently been blessed by prosperity and bull markets. This has been especially true of third, or pre-election, years, but not so much fourth, or election, years.

A study by Charles Schwab in 2016 found that in the 65 years ended 2015, the average gains during presidential cycles were as follows: year one, 6.5 per cent; year two, 7.0 per cent; year three, 16.4 per cent; and year four, 6.6 per cent. These numbers support the notion of a strong third year, but not so much the fourth year, which comes out slightly ahead of the first year and behind the second year.

There are several suggested reasons for why the presidential election cycle indicator works. For one, incumbent administrations have a strong motivation to do everything in their power to improve the economy close to election time. Similarly, opposition candidates make all sorts of vote-getting promises.

Consequently, markets tend to be buoyed by optimism. After the election, however, euphoria is replaced by reality. Election promises fail to materialize and pessimism returns.

While the presidential election indicator has some rational basis for its track record, we suggest caution whenever you assess recurring market patterns like these. That’s especially the case this year, what with the coronavirus and an unpredictable president in office. Recurring market patterns may make useful pointers, but they’re no substitute for a long-term investment plan. And the key to long-term investing consists of creating and maintaining a balanced, diversified portfolio, not acting on short-term portents.

So, what do the market pundits say?

Most strategists think the S&P 500 will end the year down from where it was at the start of the year. According to the CNBC Market Strategist Survey of 16 analysts, the index has an average year-end target of 3,088. That’s down 5.2 per cent from where it began the year.

Some analysts, however, are more optimistic. The highest target is 3,435. That works out to a 5.5-per-cent gain for the year. The lowest target is 2,800, down 14.0 per cent from the beginning of the year.

This is an edited version of an article that was originally published for subscribers in the August 14, 2020, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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