Investing In A Presidential Cycle

Have you ever observed that during a presidential election, public discussions often veer toward the economic performance of the past few years? Or how presidents frequently introduce spending bills to potentially stimulate the economy? This isn't coincidental; it is tied to the Presidential Election Cycle Theory, developed by Yale Hirsch. His theory posits that markets undergo a predictable pattern following the election of a new President. What is this pattern?

In the first year of a presidency, markets typically show the weakest performance due to the introduction of possible reforms or policy changes that can lead to economic uncertainty. By the second year, markets adjust and return to a normal level of volatility. However, as the tenure progresses, the market often rebounds. This rebound is attributed to the president promoting stimulative economic policies leading up to the election, aiming to bolster their chances of re-election. Markets often thrive in the third year, buoyed by hopes of continued or new policies. The fourth year typically sees markets maintaining their strong performance.

A study conducted by Charles Schwab revealed the following average returns over a president's four-year term: First year post-election: +6.7%, second year: +5.8%, third year: +16.3% and fourth year: +6.7%.

From this data, it's evident that the market performance during the latter half of a president's tenure typically outshines the initial two years. However, it's crucial to consider the limitations of these studies due to factors such as the stock market's age, the number of presidents, and the breadth of available historical data.

In recent times, there have been deviations from the expected patterns. For instance, during Donald Trump's first year as president, the market appreciated by 19.4% but declined by 6.2% in his second year, challenging the established theory. Nevertheless, in his third year, the market soared by 28.9%, aligning with the anticipated pattern.

Where do we stand now? We're nearing the end of the third-year cycle. Despite being down by about 7% since the year's start, several other seasonality trends remain consistent. For example, the Volatility Index (VIX) usually peaks in early October after a trough in July; currently, this trend holds. The S&P typically experiences a dip at the end of its third year, starting in September, but rallies the subsequent year, a trend we're observing now. Known as the Santa Claus Rally, the S&P often dips in October, and rallies towards year-end, juxtaposing the VIX's behavior; this year offers potential for this trend to persist.

However, forecasting these trends and theories remains a challenge. With interest rates at recent highs, accelerating inflation, persistent low unemployment, and the backdrop of two foreign wars, there are a myriad factors and unforeseen "black swan" events that could disrupt these patterns and predictions.

This is not investment advice.

Image: https://www.mcoscillator.com/learning_center/weekly_chart/entering_the_4th_presidential_year/