The Presidential Election Cycle Theory
The Presidential Election Theory, developed by stock market researcher Yale Hirsch and featured in the 1967 Stock Trader’s Almanac, analyzed the stock market
data over several decades over the four-year term of sitting presidents. Hirsch’s theory suggests that stock markets perform weakest during the first two years of a presidential term when the president tends to work on the proposed policy reform that got them elected.
During the second half of their term, presidents shift their focus to improving the economy to get re-elected. As a result, many stock indices gain in value and
have shown consistent performance in the past, (but past performance is no guarantee of future results) regardless of whether the president is Democratic or Republican.
Understanding how presidential elections influence the stock market requires looking at past historical data
and linking the S&P 500 Index returns and the U.S. Presidential election outcomes. Over the last 60 years (1956 to 2016), there were 16 elections, and the S&P had positive returns 14 of these years with an average return of 9.8%. Analyzing this historical information further, the average return was higher during an election year when a Republican was elected, an above- average return of 11.8%. Simultaneously, the index return was only 7.2%, leading to a Democrat winning the race.
Even if you think that the political party that wins the election drives the stock market’s performance, this is not exactly true. What has a significant bearing on the election outcome is the stock market’s performance before the election- the year before and at least six months prior.
An analysis conducted by Charles Schwab in 2016 found that the third year of a presidential cycle tends to have suitable gains:
Average S&P 500 Index returns each year of an election cycle:
Year after the election: +6.5%
Third year: +16.4% Fourth year: +6.6%
However, many things tend to be at play during election years – especially in 2020.
Short-term stock market results can vary depending
on factors, including gridlock in the House and Senate, and whether the election involves an incumbent candidate or a sweeping election victory. Tracking trends like this in the stock market tends to be easier than understanding why they occur.
2020 is turning out to be a year, unlike any other. After an 11-year bull run, we slid into a bear market amid
the COVID-19 pandemic. It is uncertain how long the pandemic may last and how quickly we can recover once a vaccine is available. These variables make it difficult, even with the historical data we have, to determine how the fourth quarter of 2020 may play out.
History has shown there may be statistical evidence when it comes to stock market performance, but past performance does not indicate future results. When it comes to your portfolio, the economic significance is what matters. Remember that interest rates, global economic conditions, and economic expansion and contraction outweigh any President’s agenda.
These reasons are why it is important to remember that time in the market beats timing the market. Stay focused on your long-term financial strategy for stable growth in your portfolio and discuss any concerns you have with your financial professional.