What is presidential election cycle theory?
Presidential election cycle theory posits that stock market returns follow a predictable pattern each time a new U.S. president is elected. This theory was developed by Stock Traders Yearbook Founder Yale Hirsch. According to this theory, the performance of the U.S. stock market is weakest in the first year of a term, then recovers, peaks in the third year, declines in the final fourth year, and then cycles again with the next presidential election. begins.
Important points
- Election cycle theory is based on the view that changes in presidential priorities primarily affect the stock market.
- This theory suggests that markets perform best during the latter half of a presidential term, when the incumbent president is trying to stimulate the economy in preparation for re-election.
- Data from the past few decades seems to support the idea that stock prices spike during the second half of a presidential term, but limited sample sizes make it difficult to draw definitive conclusions.
Understanding presidential election cycle theory
Stock market researcher Yale Hirsch published the first edition of this book. Stock Traders Yearbook The guidebook has become a popular tool for day traders and fund managers looking to time the market and maximize profits. This yearbook introduces a number of powerful theories, including the “Santa Claus Rally'' in December and the “best six months'' hypothesis, which states that stock prices tend to decline from summer to fall.
Mr. Hirsch's maxims included his belief that the four-year presidential election cycle is a key indicator of stock market performance. Using data dating back decades, Wall Street historians hypothesized that the first year or two of a president's term coincided with the weakest period of stock performance.
Hirsch's theory is that when a chief executive enters the Oval Office, he or she is more likely to work on the policy proposals they hold most deeply and to cater to the special interests of the people who elected them.
But as the next election approaches, the model suggests the president will focus on boosting the economy in order to win reelection. As a result, major stock market indexes are likely to rise in value. According to this theory, the results are fairly consistent regardless of the president's political leanings.
Presidential election cycle theory and past market performance
A huge number of factors can affect stock market performance in a given year, some of which have nothing to do with the president or Congress. But data from the past several decades suggests that stock prices may actually tend to rise as executive branch leaders approach their next election.
In 2016, Charles Schwab researcher Lee Ball analyzed market data from 1933 to 2015 and found that the third year of a president's inauguration generally coincides with the period when the market, on average, rose the most. discovered. The S&P 500, a fairly broad stock index, has had the following average returns in each presidential cycle year since 1933.
- Year after election: +6.7%
- 2nd year: +5.8%
- 3rd year: +16.3%
- 4th year: +6.7%
Since 1930, the S&P 500's average annual return, adjusted for inflation, has been 6.34%. So while the numbers don't show a big drop in years one and two, as Hirsch predicted, they do seem to really increase in year three, on average.
However, average values alone do not tell us whether a theory has value. There's also the question of how often this third-year bump of his happens. Between 1933 and his 2019, the stock market rose 70% of the calendar year. However, in his third year of the presidential election cycle, the S&P 500 showed remarkable consistency, rising 82% of the time annually. By comparison, the market rose 59% in both his first and second years in office.
Over the past 80 years, stock markets have averaged more than 16% gains during a president's third year in office, but the limited number of election cycles makes it difficult to draw reliable conclusions about this theory.
President Donald Trump's inauguration was a notable exception to the first-year stock market slump that theory predicts. Republicans aggressively pushed for the personal and corporate income tax cuts passed in late 2017, fueling the S&P 500's rise by 19.4%. In his second year in office, the index plunged 6.2%. But again, his third year was a particularly strong period for stocks, with the S&P soaring 28.9% for him.
Limitations of presidential election cycle theory
Overall, presidential election cycle theories have mixed predictive power. As Hirsch suggested, the average market returns in years one and two have been somewhat weak overall, but the direction of stock prices has been inconsistent from cycle to cycle. The bullish trend in the third year is more reliable, with the average rate of increase much higher than the rate of increase in other years.
But questions remain about whether investors can feel comfortable timing the market based on Hirsch's assumptions. Since presidential elections in the United States occur only once every four years, we do not have a large enough sample of data to draw definitive conclusions. Since 1933, only 23 elections have been held.
And even if two variables (in this case election cycle and market performance) are correlated, that doesn't mean there is a causal relationship. Markets may tend to soar during the third year of a president's presidency, but it's not due to a reprioritization by the White House team.
This theory is based on an inflated estimate of presidential power. In any given year, the stock market can be affected by a variety of factors that have little or nothing to do with top management. Presidential influence over the economy is also limited by the increasingly globalized nature of the economy. Political events and natural disasters can affect markets in the United States, even on other continents.
special considerations
In a 2019 interview wall street journalJeffrey Hirsch, son of the creator of presidential election cycle theory and current editor. Stock Traders Yearbook, showed that this model still has merit, especially when it comes to the third term. “The president is campaigning from a bullish pulpit and insisting he stays in office, and that tends to push the market higher,” he told the publication.
However, in the same interview, Hirsch also acknowledged that this theory is susceptible to idiosyncratic events in a particular cycle that can affect investor mood. He noted that the composition of the Senate and House of Representatives, for example, can also be an important determinant of market movements. “There's no need to jump to conclusions when you don't have many data points,” he said. journal.
What is Santa Claus Rally?
The Santa Claus Rally refers to an observed trend in the stock market rising from the last five business days of one year to the first two business days of the next year. Similar to the presidential election cycle, the idea of a Santa Claus rally was introduced by Yale Hirsch.
What is the cause of the Santa Claus rally?
There is no exact explanation as to the cause of the Santa Claus Rally. According to historical data, Santa Claus rallies have been held about 80% of the time from 1950 to 2022. Factors that may be contributing to the Santa Claus rally include holiday shopping optimism, bonus investing, and the relative increase in activity of individual traders over institutional investors.
In which month are stock prices typically lowest?
Historically, the S&P 500 averages its lowest returns in September. Traditionally, September and October are both considered “down months.” However, these are both general observations, and market performance in a given year can sometimes follow previous trends, or sometimes deviate from it.
conclusion
Presidential election cycle theory holds that stock market performance may follow a generally cyclical pattern related to presidential terms. This suggests that the market performance is weakest in the first year of the period, then recovers and reaches its peak in the last two years of the period. The idea that presidential cycles might be an indicator of market performance Stock Traders Yearbook. This is supported to some extent by past data. On average, the S&P 500 index has recorded its largest increase in his third year of a presidential term. However, this theory also has notable limitations, including the fact that cyclical trends in market performance are more likely to be a matter of correlation than causation.
