Analyst Spotlight Archive

Analyst Spotlight: Rachel Zibrak

The Presidential Election Cycle Theory, developed by Yale Hirsch, states that markets behave in a somewhat predictable pattern based on a president’s four-year term. History indicates that both pre-election and election years are usually strong for stocks, while post-election and mid-term election years are mixed. Looking at returns from 1900-2006, 81% of the time returns were positive during a pre-election year and 78% were positive during an election year.

Some investors think that the economy declines the first two years after a president is elected because investors are uncertain of a president’s real agenda. A first-term president wants the economy to have any bad news and interest rate hikes to happen early so that by re-election time the economy is doing well again. That creates anxiety in the stock market for the first couple of years. It’s commonly believed that mid-way through the cycle, the public becomes familiar with the president, and the economy picks up. It is also believed that the president’s focus changes to improving the economy in order to get re-elected. The administration, with the cooperation of Congress, will boost spending and cut taxes in the third year of the president’s term to give the economy a lift. Consequently, stocks rise in anticipation of brighter economic conditions. The third year of the cycle (the pre-election year) has historically been the best performing year. Since World War II, the stock market has never had a negative pre-election year and it has suffered only three down years in an election year. Most recently, the S&P 500 was up 4.9% in 2005 and 15.8% in 2006. So, if the pattern holds, 2007 could return more than 15.8%. The average return for the pre-election years since 1900 is 11.5%. However, in 2007, President Bush is serving out his second term. The market does not perform as well as the overall average in the pre-election years of second-term presidents, with an average gain of 7.4% vs. a 13.1% gain for first-term pre-election years. Of the most recent presidents serving two terms, the market performance during the second-term pre-election year in 1999 with Clinton was 19.5% and 2.0% in 1987 with Reagan.

The average return for the election years since 1900 is 9.5%. Some even feel that the Federal Reserve accommodates the party in power by lowering interest rates, holding rates steady, or delaying interest rate increases. The market usually strengthens as Election Day approaches. According to U.S. News & World Report, only five times in the past 28 election cycles has the Dow failed to hit, or come within five percent of the year’s high, during the three-month period surrounding a presidential election. In three of the cases where it didn’t, the economy was already in a recession. Recessions have no political affiliation. For the period 1871-1997, the average annual returns for Republican and Democratic administrations were 10.5% and 11.7%, respectively. Since World War II, the average annual return under Republicans has been 13.1% and 15.3% for Democrats. In 2000, the average return was negative. It was the only election year in the post World War II period to have negative returns.

Some advisors feel so strongly about how the election affects stock market returns that they give advice and make asset allocation decisions based only on the election cycle. For the last election, one investment advisor recommended to his newsletter subscribers on the night before the election to only make a 50% portfolio allocation to equities. We think this is a more drastic approach. Just using one factor such as the presidential elections to make an investment decision could result in significant losses to your portfolio. We think it should be included in the many factors used to make asset allocation decisions but in no way should it be the sole criteria. We will continue to maintain diversified portfolios through each year in the presidential election cycle.

-- Rachel Zibrak