Presidential Elections and Stock Market Cycles

Can you profit from the relationship?

2004 Volume 7 Issue 3

For the past several decades, individuals in all walks of life have observed the cyclical nature of the stock market. Pundits have attempted to correlate these cycles with everything from referencing the position of the moon and stars to using highly sophisticated econometric models. This article, however, attempts to address the timely relationship between politics and stock market behavior.

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)

Dates of Peaks & Troughs Peaks/ Troughs S & P Price Length of Bull Market (years) Bull Market Rise (%) Length of Bear Market (years) Bear Market Decline (%) Full Cycle in Years
4/42 Trough 7.47
5/46 Peak 19.25 4.08 158%
10/46 Trough 14.12 .36 -27% 4.45
6/48 Peak 17.06 1.68 20%
6/49 Trough 13.55 .99 -21 2.68
1/53 Peak 26.66 3.56 97%
9/53 Trough 22.71 .69 -15% 4.25
8/56 Peak 49.74 2.88 119%
10/57 Trough 38.98 1.22 -22% 4.10
12/61 Peak 72.64 4.14 86%
6/62 Trough 52.32 .54 -28% 4.68
2/66 Peak 94.06 3.62 80%
10/66 Trough 73.20 .66 -22% 4.28
11/68 Peak 108.37 2.15 48%
5/70 Trough 69.29 1.49 -36% 3.63
1/73 Peak 120.24 2.63 74%
10/74 Trough 62.28 1.72 -48% 4.36
9/76 Peak 107.83 1.97 73%
3/78 Trough 86.90 1.45 -19% 3.42
11/80 Peak 140.52 2.73 62%
8/82 Trough 102.42 1.70 -27% 4.44
8/87 Peak 336.77 5.03 229%
12/87 Trough 223.93 .28 -34% 5.31
7/90 Peak 368.95 2.61 65%
10/90 Trough 295.46 .24 -20% 2.85
2/94 Peak 482.00 3.31
4/94 Trough 438.92 .17 -9 3.48
7/98 Peak 1186.74 4.25 170%
8/98 Trough 957.28 .08 -19% 4.30
3/00 Peak 1527.45 1.58 60%
10/02 Trough 776.75 2.5 -26% 4.02
Averages 3.08 yrs 93% 0.94 yrs -26.4% 4.02

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

Presidential Term Month and Year
of Market Bottom
Year During
Presidential Term
When Market Bottomed
1942 – 1944 4/42 2nd Year
1945 – 1948 10/46 2nd Year
1949 – 1952 6/49 1st Year
1953 — 1956 9/53 1st Year
1957 – 1960 10/57 1st Year
1961 – 1964 6/62 2nd Year
1965 – 1968 10/66 2nd Year
1969 – 1972 5/70 2nd Year
1973 – 1976 10/74 2nd Year
1977 – 1980 3/78 2nd Year
1981 – 1984 8/82 2nd Year
1985 – 1988 12/87 3rd Year
1989 – 1992 10/90 2nd Year
1993 – 1996 4/94 2nd Year
1997 – 2000 8/98 2nd Year
2001 – 2004 10/02 2nd Year
Average = 1.87 years into presidential term

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

Presidential Election Dates Percent Change from Oct 1 of 2nd yr of Presidential term through Dec. 31 of election yr. (Investor 1 strategy) Percent Change from Jan. 1 of inaugural yr through Sept. 30 of second yr of presidential term (Investor 2 strategy) Investor 1 dollar results (beginning with $1,000) Investor 2 dollar results (beginning with $1,000)
1952 +35% +22% $1,350 $1,220
1956 +45% +8% $1,956 $1,318
1960 +16% -2% $2,271 $1,291
1964 +52% -9% $3,451 $1,175
1968 +39% -19% $4,798 $952
1972 +40% -47% $6,717 $505
1976 +70% -4% $11,418 $483
1980 +32% -12% $15,072 $425
1984 +37% +40% $20,649 $595
1988 +19% +11% $24,571 $660
1992 +38% +7% $33,909 $707
1996 +60% +42% $54,254 $1,004
2000 +34% -36% $72,701 $643

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.


[1] John Maynard Keynes, General Theory of Employment, Interest and Money, 1936. Republished by Harcourt, Inc. (1964).
A further discussion of Keynesian economics can be found in most college level textbooks on economics. There are also websites devoted to his work, e.g., http://cepa.newschool.edu/het/essays/keynes/keynescont.htm or http://www-gap.dcs.st-and.ac.uk/~history/Mathematicians/Keynes.html

[2] Yale Hirsch and Jeffrey Hirsch, The Stock Trader’s Almanac 2004, Hoboken, NJ: John Wiley and Sons, (2004): 127.

About the Author(s)

Marshall Nickles, EdD, has been instrumental in the development of Pepperdine's School of Business and Management. He has also been a consultant to several corporations such as Volkswagen of North America, 3M Corporation and Loctite Corporation. In addition, he has served as a board member to The China Economy Consultancy Co. in the People's Republic of China, The China American Technology Investment Group, vice president and board member of The American-China Association for Science and Technology Exchange, and advisory board member for Irwin Duskin Press. Dr. Nickles has also been a frequent presenter and discussant of professional papers at national and international academic associations. He has been a former financial columnist for The Orange County Business Journal and Business to Business Magazine. Prof. Nickles is the author of an economics text and more than 45 articles. Dr. Nickles has been quoted on television, and in several newspapers and magazines, such as The Wall Street Journal, USA Today, the New York Times, the Orange County Register, Barron’s Weekly, Stocks & Commodities Magazine, and the Los Angeles Times . He has been an invited guest on KNX 1070 radio, KTLA Channel 5, Fox Television, CNBC, and as the principal speaker at the national conference of the State Bureau of Statistics in Beijing, China. Prof. Nickles was the recipient of the Howard A. White distinguished teaching award at Pepperdine’s Graziadio School of Business and Management.

Comments

Peter Duffy

December 16, 2011 at 7:48 am

Interesting read. Very good.


Arlene C

February 25, 2012 at 10:56 am

Excellent article. It is good to read an article that explains everything clearly and contains everything you wanted to know in simple words and charts. Very interesting, I really enjoyed it….Thank You Marshall Nickles, EdD


Idan

April 9, 2012 at 12:31 am

Very good article.
mind that this method performed terribly during the 2008 elections.


Yap

April 18, 2012 at 6:44 pm

Hi, great article, however, I tried briefly to verify table 2, and found myself disagreeing that 1994 and 1998 were troughs as indicated by the table. 1998 for example, S&P prices were much higher than 1996, so post-1996 elections, there was no slump in market. The same goes for the 1992 elections.


Obama

June 21, 2012 at 3:52 pm

As another poster commented, 2008 was an election year but a big down year and certainly a bear market. For that cycle you would have been far better off buying in October of 2009.

We have had corrections every year since 2008. This is an election year, but the 2008 election year failed us. However the system would have indicated a buy in October of 2010, in the high 1100 range. At a conservative 20%, that would set the election year finish to the low to mid 1300s. We are currently right at that point after today’s big drawdown.

So the question is whether we get a 2008 style collapse or if the regular pattern continues. Aside from election years, year end rallies usually happen, so even with a drop and a short term bear market, we could still finish up to the projected trend target on the low end. If we are indeed in a bear market, it was probably signaled in April, which would set October as a possible trough.


Jack

July 25, 2012 at 7:13 am

Thanks for artcle. What happened to investor 3 that dollar cost averaged the entire period? In the middle, a little under, or over?


Benn

August 26, 2012 at 4:57 pm

Now that we have seen an early rally from Jan 2011-Aug 2012…Can this theory work when the market has done so well during these last 17 months it does not support this theory’s predictions? I do not see any clear trends yet even though the market is up during these last 17 months…then is this theory missing a derivative that reinforces it? I see growth for last two years are we now expected to see a collapsed market for the next two years. Does the 2 years growth then two years decline cyclical projections seem to make sense now.


John Schmertz

October 4, 2012 at 7:54 am

Thought you folks might be interested in this site. Has a number of different views of the major secular market cycles of the last 100 years: http://www.macrotrends.org/series/stock-market-cycles


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