Election Cycle Departs from Historical Trends

Did you know that stocks rally in the year leading up to a U.S. presidential election? Although market volatility remains this year’s story, a solid rally has been the historical trend.

In “Trade the Election,” David Keller, managing director of research with Fidelity Asset Management, does a great job of presenting the facts. He reports how Wesley C. Mitchell, co-founder of the National Bureau of Economic Research (NBER), developed the 40-month cycle theory. Mitchell found that, from 1796 to 1923, the U.S. economy fell into a recession every four years on average, excluding the years of four major wars. Later, stock market historian Yale Hirsch connected Mitchell’s four-year pattern to U.S. presidential elections. Hirsch reported that, from 1832 until the 2004 election, the stock market had risen 557% during the last two years of each administration, a rate of 13.6% per year. However, the market posted just an 81% gain during the first two years of a president’s term, a rate of 2% per year. That’s quite a differential. Hirsch has also noted that, since 1965, none of the 13 major stock market lows occurred in the last year of a president’s four year term, while nine downturns happened in the second year.

You’ll notice that 2008 is absent from this cycle analysis. In fact, the 2008 financial crisis resulted in a huge market decline during President George W. Bush’s final year in office. So have the recent recession and the ensuing European debt crisis combined to thwart the presidential cycle? And where does that leave us?

David Keller sums it up this way, “You have to remember that the presidential cycle happens in the context of larger structural market trends, and that secular moves in equities can either enhance or minimize the effect of something like a four-year market cycle.”

I agree that plenty of extraneous factors can affect these cycles. Accordingly, the presidential cycle is more entertaining cocktail conversation than solid investment strategy.