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Understanding the Presidential Election Cycle Theory

November 13, 2020 · 5 minute read

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Understanding the Presidential Election Cycle Theory

The Presidential Election Cycle Theory suggests that the stock market follows a pattern that correlates with a U.S. president’s four-year term.

The first two years of a term tend to be the weakest for stocks, according to the theory, as the president focuses on fulfilling campaign promises, but the market improves in the latter half of a term as the president pumps up the economy ahead of a new election.

Some historical stock market data does tend to sync up with the Presidential Election Cycle Theory, but past performance is not indicative of future results.

And market researchers and investors tend to be doubtful of the strategy, chalking it up to statistical coincidence as opposed to a real sign of a U.S. president’s power over the market.

They argue that company earnings, global economic data, and Federal Reserve monetary policy tend to be bigger influences on stock prices.

What is the Election Cycle Theory?

The Stock Trader’s Almanac has data going back to 1833 in order to study the Presidential Election Cycle Theory. Below are the average stock market percentage gains in the four calendar years after a presidential election, according to the almanac’s 2020 edition.

Hirsch used the Dow Jones Industrial Average to track stock market performance after 1896 and other stock gauges for the years prior:

Postelection year: 3%
Midterm year: 4%
Preelection year: 10.2%
Election year: 6%

In a Wall Street Journal interview in November 2019, however, Jeffrey Hirsch, the son of Yale Hirsch, said that not all the historical data is relevant. Market observers have argued that going further back in history, U.S. presidents had even less sway over the stock market than in current times.

But according to Hirsch, the theory that the stock market is strongest in the third year of a presidential term has held up.

The almanac states that since 1943, in the third year of the presidential election cycle, both the Dow and S&P 500 have been up 15% on average. Meanwhile, since 1971, the Nasdaq indices have climbed 28.8% on average in the third year.

That’s because “incumbent administrations shamelessly attempt to massage the economy so voters will keep them in power,” the almanac states.

Stimulative fiscal measures designed to increase disposable income and a sense of well-being in the voting public have included:

•  Increases in federal budget deficits, government spending, and Social Security benefits
•  Interest rate cuts on government loans
•  Speedups of projected funding

Other points in the Presidential Election Cycle Theory:

•  Wars, recessions, and bear markets tend to occur in first two years; prosperity and bull markets in the second two years
•  The market performed better in election years when a sitting president is running. Since 1949, the Dow climbed 10.1% during election years when the incumbent is up for reelection vs. 5.3% in all election years and 1.6% in years with an open field
•  Times when the stock market rose between August and October in a presidential election year, the incumbent political party has retained power 85% of the time since 1936
•  Markets tend to be stronger when the incumbent party in power wins

Does History Back Up the Presidential Election Cycle Theory?

The Presidential Election Cycle Theory hasn’t held up well in recent presidential administrations. The S&P 500 posted a strong gain of 19% in 2017, the first year of President Donald Trump’s term. The market also surged 29% in 2019, Trump’s third year and the best annual performance of his administration.

In each of President Barack Obama’s two terms, the first year saw the best annual performance, with the S&P 500 rallying 23% in 2009 and 30% in 2013.

Separately, the stock market has tended to rise more than fall, making the case that charting patterns with the election cycle may have more to do with coincidence. Since 1833, equity prices have risen in 115 calendar years and fallen in 70, data from the Stock Trader’s Almanac shows.

Barron’s also noted in November 2019, citing data from Ned Davis Research, that the weakest time in a four-year presidential cycle has historically actually been September of the pre election year to May of the election year.
Once the winner is determined, the market tends to rally regardless of political party.

Other political factors could also be in play, such as midterm elections. Barron’s also wrote in 2018 that the stock market’s performance during midterm election years hasn’t been stellar. Since 1942, the S&P 500 has gained 6% on average in midterm years, compared with 9.1% during the average year, the article stated, citing Ned Davis Research.

What About This Time Around?

Election Day was Nov. 3, and the new four-year presidential term will start on Jan. 20. Trump has been waging legal challenges to state ballot counts, while the S&P 500 rallied after some media outlets declared Joe Biden the winner.

In the past, uncertainty over the outcome of a presidential election has led to declines in the stock market. In 2000, confusion over hanging chads in the Florida ballot count meant the race between George W. Bush and Al Gore didn’t come to a swift conclusion.

Investor uncertainty over the outcome caused the stock market to plummet. Markets rebounded after the Supreme Court decision that ultimately resulted in a Bush win.

The conventional wisdom on Wall Street has been that a split government usually leads to strength in the stock market, as the division in power will lead to less ambitious policy changes.

So the potential outcome of a Democrat in the White House and both parties splitting Congress could lead to gains for the Dow and S&P 500. That said, business publications have reported that there is little evidence to back this idea up.

In the 45 years that the same party controlled Congress and the presidency, the S&P 500’s average return was 7.45%, the Wall Street Journal found. In the 46 years power was split, the average return was 7.26%. The index actually slightly outperformed when control of the presidency and Congress was unified under one party.

What Does The Presidential Election Cycle Mean for Investors?

The history of U.S. presidential elections may not be a big enough sample set for making investment decisions.

The Wall Street Journal also pointed out that there has been no previous period when Democrats controlled the White House and the House of Representatives while Republicans controlled the Senate—a possible scenario in 2021.

That means investors could be in uncharted territory applying the Presidential Election Cycle Theory to the stock market in 2021.

An array of factors beyond presidential election cycles also influences share prices. Investors typically monitor company earnings, global and U.S. economic data, events like natural disasters and pandemics, and Federal Reserve monetary policy. Separately, periods of uncertainty—whether in monetary or fiscal policy—can also shape market performance.

Annual returns also don’t capture the volatility that could have happened during the year. For instance, the stock market has rallied in 2020, but it also entered into a bear market, a drop of 20% or more, in the first half amid investor worries over the COVID-19 pandemic’s impact on the global economy.

The Takeaway

The Presidential Election Cycle Theory states that the stock market’s performance improves in the four-year terms of US presidents as they gear up for reelection. Some investors say, however, that other factors, like corporate earnings and central bank policy, are bigger influences on share prices.

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