2004, Volume 07, Issue 3

Presidential Elections and Stock Market Cycles

Can you profit from the relationship?

Marshall D. Nickles, EdD

During the first half of the twentieth century, economic theory was limited primarily to the micro study of supply and demand theory. Minimal concern was given to the macro economic environment. However, after World War II, the work of John Maynard Keynes, an English economist, began to dominate Western economic thinking with a broad macro view of economics. First presented in 1936 by Keynes, this approach was the beginning of macro economic theory. It called for governments to prescribe specific macro economic policies in an effort to ameliorate business cycles. By the late 1950s, Keynesian theory was widely accepted in academic circles and was being taught at most major U.S. universities.[1] The federal government began to embrace Keynesian economics by the early 1960s, and from that time forward, Washington has played an active role in influencing the direction of the economy.

It’s the Economy, Stupid

It wasn’t long before politicians recognized the relationship between voter approval and the state of the economy. The Federal Reserve has responsibility for monetary policy such as interest rates and alterations in the money supply, and the executive branch has limited ability to influence that part of the economy. However, the executive branch of government can influence fiscal policy—changes in taxation and spending patterns. Administrations have often yielded to the temptation to exercise fiscal policy in a manner designed to pump up the economy just prior to a presidential election and thus garner voter approval for the incumbent party. These pre-election actions and campaign promises often have created some euphoria among voters and investors alike.

On the other hand, post-election periods seem to have suffered from an opposite effect that has resulted in less investor optimism. In The Stock Trader’s Almanac, 2004, Yale Hirsch notes that based on his studies, “Presidential elections every four years have a profound impact on the economy and the stock market. Wars, recessions and bear markets tend to start or occur in the first half of the term and bull markets, in the latter half.”[2]

Because of the consistency and predictability of administrative actions and campaign rhetoric and their anticipated influences on the economy, investors have come to assume better times for business conditions, corporate bottom lines, and stock prices in the period prior to a presidential election and a less robust period following those periods. Thus, a four-year stock market cycle seems to have become a part of the investment landscape since the mid-twentieth century. From April, 1942 to October, 2002, 15 stock market cycles have occurred, each averaging approximately four years’ duration.

Major market cycles usually have abrupt “V”-shaped bottoms with declines in excess of 10 percent. The following stock market recoveries are often created (as suggested earlier) by strong economic stimulus invoked by government officials in an effort to counter potentially unpopular economic recessions. Strong doses of fiscal and/or monetary policy stimuli unfortunately often result in creating inflation, which then must be addressed, thereby perpetuating the business and stock market cycles. Given the foregoing scenario, it is not at all surprising to find that the stock market often has made major bottoms about two years before presidential elections and has risen through the end of election years.

To illustrate this pattern, consider the historical performance of the commonly used Standard & Poor’s 500 Index (S&P 500). This Index consists of 500 top U.S. companies, and it is used by Wall Street as a benchmark for tracking the overall stock market. Table 1 below shows the historical stock market cycles from 1942 – 2002.

Table 1
Historical Stock Market Cycles for the S&P 500 Index
(1942 – 2002)

As we can see from Table 1, full cycles occur approximately every four years. During this period, bull markets averaged about three years, while bear markets averaged less than a year. A more detailed investigation that includes presidential election cycles for the period from 1941 through 2000 reveals some interesting findings. Stock market lows have occurred surprisingly close to mid-year congressional elections, or approximately two years before presidential elections. (See Table 2.)

Table 2
Presidential Elections and Market Troughs

Table 2 clearly shows a clustering of bear market lows around the congressional election period, or about two years into the presidential term. As can be seen, three of the 16 bear market lows occurred in year one of the presidential term, 12 in year two, one in year three, and none in year four (the election year).

Potential Investment Strategies Based on the Political Cycle

Price data for the S&P 500 Index was compiled and averaged on a weekly basis over the period from 1942 to 2003. Analyses of these data suggest that a potentially lucrative investment strategy would have included buying on October 1 of the second year of the presidential election term and selling out on December 31 of year four. This simple strategy would have sidestepped practically all down markets for the last 60 years. For the most part, bear markets have historically occurred during the first or second years of presidential terms. (A bear market is defined here as the S & P 500 Index's decline approximately 15 percent or more over a period of one to three years, while a bull market is an environment of consistently rising prices.) As shown in the above table, no bear markets of this magnitude have occurred during an election year for the time covered.

It is also apparent that markets are subject to change from time to time because of unforeseen macro events. As a result, some cycles have been shorter and some longer than the norm. For example, 1946 to 1949 was a shorter cycle, while 1982 to 1987 and 1994 to 1998 were longer than average cycles. One cannot point to any one factor that has directly caused bull market runs of the last two decades to be longer in duration than those during previous decades. To speculate on the above is beyond the scope of this paper, although fundamental economic conditions and the role of the Federal Reserve are factors.

The Test

Based on discussions above and the notion that the S&P 500 Index seems to bottom approximately two years into presidential terms (Table 2), we can construct a hypothetical test for two investors that calculates the dollar return for two simple alternative investment strategies. In neither case is allowance given for possible dividends or interest earned. In addition, commissions and taxes are ignored for the purpose of simplicity. Prior to the 1952 presidential election, the U.S. government generally did not attempt to influence the economy in any significant way, so the period before 1952 (except for the World War II period) is not useful for testing this strategy. Therefore, the test begins with the 1952 election period.

Imagine that the first investor had consistently purchased the S&P 500 Index 27 months before presidential elections and had sold near election time on December 31 of the election year. Because a 27-month period seems to provide better returns than other studied periods before the election, a 27-month period was selected for this test. This strategy kept Investor 1 out of the market from January 1 of the inaugural year through September 30 of the second year during the test period. On the other hand, imagine further that Investor 2 bought the S&P 500 on the first trading day of the inaugural year of each presidential election during the test period and liquidated the portfolio on September 30 of the second year of the presidential term. Would either or both of these simple procedures have consistently made money for the investors? Table 3 below reveals the results on both a percentage change basis and dollar return.

Table 3
Percentage and Dollar Returns of Two Investment Strategies
(Dollars Amounts are Cumulative)
Starting Value for Investors 1 and 2 = $1,000

The findings in Table 3 are extremely interesting. The first investor put up money 13 times and did not lose money in any period. Gains ranged from a high of 70 percent prior to the 1976 election to a low of 16 percent before the 1960 election. Investor 1 saw the original investment of $1,000 grow to $72,701. This is a percentage gain of 7,170 percent. Investor 2 was not so fortunate. This individual also anted up 13 times, but lost six times. The largest loss of -36 percent was seen after the presidential election of 2000. Investor 2 saw the original $1,000 shrink to only $643, or a loss of -36 percent, in nearly five decades. That percentage is based on nominal dollars and does not include the impact of inflation.

Graphing the percentage gain and loss makes the difference quite obvious.

However, when you look at a graph of the cumulative dollar difference between the two strategies, the difference is even more dramatic!

Final Thoughts

It is not the intent of this paper to forecast the stock market. Even where patterns exist, there is enough variability that it is risky to try to anticipate specific turns in the market. Yet we have identified a potentially profitable four-year stock market cycle that has worked well over the better part of the last century. Investing for the 27 months before a U.S. presidential election certainly seems to be more profitable than investing during the 21 months after the elections.

However, just when you think that you have figured it all out, you find another pattern that can suggest different possibilities. For instance, another analysis shows a highly intriguing re-occurrence in the stock market index. During the entire twentieth century, every mid-decade year that ended in a “5” (1905, 1915, 1925, etc.) was profitable! This is not to say that all of these years had uninterrupted ascending trends, but by year’s end there had been impressive gains. Whether that pattern was a fluke or will continue in the 21st century is anyone's guess.   And, 2005 is also an inaugural year.

However, trying to figure out such patterns can certainly make life interesting.

Comments (20)

I'm doing a report on the ups and downs in the stock market over the last calendar year. Do you have any sites you recommend I look up to support and help my research? ...Monique 7/6/2008 10:38:12 PM

Interesting article. I wonder if it holds any credence for the last two-to-three years. ...Shirley 8/8/2008 12:55:43 PM

Read this article. ...Nancy 9/8/2008 8:57:03 AM

The investor 1 vs 2 comparison is silly. 27 of 48 months invested vs. only 21 of 48 months. What about 28 vs. 20? How about 47 vs. 1? Who do you think will come out ahead? Your money can't grow if it's not invested. Secondly, why does the author not show what happens if investor 2 simply buys and holds for the entire 48 months. Oh.., and look what's happening this election cycle. The market is down like we've never seen it just prior to the election. Back to the drawing board I guess.  ...Charles Goldman 9/30/2008 11:59:45 AM

Very Interesting, The historical stock market table in exhibit 1 helps to re assure me it could pay to stay in the game, even when I am looking into the market abyss currently. ...Scott Pinheiro 10/9/2008 5:49:59 PM

Charles Goldman does rasie a valid point. I would like to see the difference of being invested from 1952 to 2000 without leaving the market at all... Espaically if you consider the effects of capital gains taxes... But this article does rasie a very interesting suggestion about market timing. ...Kyle 10/13/2008 2:25:05 PM

This is a very interesting market account. I will test this theory out for the first time. I will let you know. I do wonder after the election do we really expect to see a significant change? I do hope so. ...Bill  10/23/2008 10:45:35 PM

While article makes some compelling arguments, the fundamental ideas of stock market movement being a result of the calendar events is supersticious and dangerous at best. While everyone can be encouraged to pursue such strategies, if it were that basic, everyone would be rich. The current treacherous state of the market and economy guarantee nothing until it starts to meet resistance and eschew the Alan Greenspan's-coined "exuberant enthusiasm". However it will be fun to watch and I'm patiently waiting with the curson on the buy button.  ...Max 10/27/2008 3:49:25 PM

Fascinating, but hard to implement, isn't it? Had I been following this analysis, I would have bought into the market in roughly August of 2006 and be waiting for roughly December this year to sell? Have I got it right? In actual fact, I got worried about the market and the economy and pulled my TSP funds out of the S&P 500 fund and put them into government bonds in April of 2007. I missed the subsequent market peak,but also the current down. My problem is trying to use this analysis to get back into the market at an appropriate time. Again, if I understood correctly, that would be roughly late 2010? Quite a bit of my future rests on that bet, and I wonder if it is the right one? ...Robert DeVere 10/29/2008 12:42:17 PM

There may be some truth to some of this but like he said tomorrow it can all be different. I heard Tom Hougaard from City Index say the market will bottom ~ mid next year back below 8000 with a turning point into a Bull another 1-1.5 years away. Kind of fits into this political cycle philosophy. Have we hit bottom? 5:34 Tom Hougaard, chief markets analyst at City Index discusses when the global stock markets might hit bottom.http://www.cnn.com/video/#/video/business/2008/10/31/vassileva.uk.recession.song.cnn Added On October 31, 2008 ...William Leigh 11/1/2008 10:41:45 PM

People believe what they want to believe. The numbers are the only reality. The overwhelming probability of strong profit based on this premise is timeless and universal. All the other talk about why it might not be good is only traditionalists (probably Fund bokers) trying to calm their fear of...CHANGE. The only thing that matters is grandpa's retirement and how much money you have to go fishing. The formula is not required to include every variant since Aristole. I'm sure there are some brilliant people who could expand the idea - but then I know some who still prefer DOS over Windows. Be wise and listen to the numbers.  ...Steve McCurdy 11/10/2008 8:16:16 AM

I will test this theory out for the first time. I will let you know. I do wonder after the election do we really expect to see a significant change? ...alex 12/3/2008 10:30:54 PM

I missed the subsequent market peak,but also the current down. ...Oliver 12/19/2008 2:24:10 AM

The market is down like we've never seen it just prior to the election. Back to the drawing board I guess. ...Jeena James 12/25/2008 9:43:27 PM

The market is down like we've never seen it just prior to the election. Back to the drawing board I guess. ...murat 1/12/2009 4:41:58 PM

A lot of analysis and words, but inconclusive, the nature of the market. Thanks for the article. ...jay 1/16/2009 11:21:23 AM

I will test this theory for the first time. However I feel that lot of analysis is required. ...Kreena 1/24/2009 12:30:17 PM

Frankly speaking 2 days ago I used this theory in my research paper writing. But some helpful materials I found in this post. ...John 1/27/2009 9:30:33 AM

Good materials for profound research project. ...Jason 2/1/2009 3:43:11 AM

excellent article nowadays. if you can't profit there is always cash advance available on the net for students. As we all know Obama hasn't been doing much lately for the economy but at least the market has been rallying recently in March of 2009. ...Josh Powell 3/16/2009 8:50:50 PM

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