The Presidential Election and The Stock Market – The Link
The ups and downs of the stock market are known phenomena and several such ups and downs have been observed over the last several years. There have been several explanations given by several learned people trying to explain the reasons behind the ups and downs. Right from the effect of the heavenly bodies to very complicated theories have been laid down trying to explain his cyclical nature of the stock market. Politics plays a major role in determining the ups and downs of the stock market, which is explained below.
The first part of the twentieth century saw several economic theories and explanations given to study the micro economic phenomena. The macro economic point of view was explained or taken into consideration only after the Second World War when the economist “John Maynard Keynes” brought forward the concept of the macroeconomic theory. First put forward in the year 1936, the 1950s saw the popularity of the concept of macroeconomic theories. Keynesian economics became very popular and was taught at US universities and colleges.
The Economy
The connection between the condition of the economy and the approval of the voters was understood during the time. The Federal Reserve handles the monetary aspect of the economy related to issues like the rate of interest and money supply whereas on the other hand it’s the executive branch looks after matters like the fiscal policy which aims at making an impact through taxation and other such tools.
There has been a trend wherein the fiscal policy is used to create a boom or a positive atmosphere in the economy close to the Presidential election and thus, have the voter on your side. The promises made during the presidential elections and the actions taken to create a sudden positive impact in the economy have often managed to create a wave and achieve the desired results.
The pre-election times have seen a positive impact leading to investor confidence, whereas on the other hand, the post election phase seems to be just the opposite with the investor not finding the market attractive at all. Yale Hirsch is known to have commented regarding how the Presidential election that is held every 4 years has a very far-reaching impact on the economy as a whole and the stock market in particular.
The observed phenomenon goes to show that the trend is a bearish market at the outset followed by a bullish market in the second part of the term.
With the trend continuing for several years now of a boom time in the economy just before the presidential elections, the investors have started taking things for granted now. The investors know by now that generally the time before the presidential elections is best suited for investments in stocks and in business.
From the twentieth century onwards the stock market cycle the ups and downs seen every four years has become a part of our lives. From the period 1942 to 2002, there have been 15 stock market cycles that we have witnessed.
The graphs of the major cycles witnessed in the stock market show a “V” shaped graph. The Government steps in play an important role to revive the market in case of a major crash. Several monetary and fiscal measures are taken by the Government so as to reverse the situation.
The general trend that has been observed over the years goes to show that the stock market crashes two years before the Presidential elections and then close to the elections makes a quick recovery.
This phenomena can be observed in the below given table which shows the stock market cycle that have been witnessed from 1942-2002 using the S&P500 Index which includes the top 500 US companies.
Table 1: Historical Stock Market Cycles for the S&P 500 Index (1942 – 2002)
Dates of Peaks & Troughs |
Peaks/ Troughs |
S & P Price |
Length of Bull Market (years) |
Bull Market Rise (%) |
Length of Bear Market (years) |
Bear Market Decline (%) |
Full Cycle in Years |
4/42 |
Trough |
7.47 |
|
|
|
|
|
5/46 |
Peak |
19.25 |
4.08 |
158% |
|
|
|
10/46 |
Trough |
14.12 |
|
|
.36 |
-27% |
4.45 |
6/48 |
Peak |
17.06 |
1.68 |
20% |
|
|
|
6/49 |
Trough |
13.55 |
|
|
.99 |
-21 |
2.68 |
1/53 |
Peak |
26.66 |
3.56 |
97% |
|
|
|
9/53 |
Trough |
22.71 |
|
|
.69 |
-15% |
4.25 |
8/56 |
Peak |
49.74 |
2.88 |
119% |
|
|
|
10/57 |
Trough |
38.98 |
|
|
1.22 |
-22% |
4.10 |
12/61 |
Peak |
72.64 |
4.14 |
86% |
|
|
|
6/62 |
Trough |
52.32 |
|
|
.54 |
-28% |
4.68 |
2/66 |
Peak |
94.06 |
3.62 |
80% |
|
|
|
10/66 |
Trough |
73.20 |
|
|
.66 |
-22% |
4.28 |
11/68 |
Peak |
108.37 |
2.15 |
48% |
|
|
|
5/70 |
Trough |
69.29 |
|
|
1.49 |
-36% |
3.63 |
1/73 |
Peak |
120.24 |
2.63 |
74% |
|
|
|
10/74 |
Trough |
62.28 |
|
|
1.72 |
-48% |
4.36 |
9/76 |
Peak |
107.83 |
1.97 |
73% |
|
|
|
3/78 |
Trough |
86.90 |
|
|
1.45 |
-19% |
3.42 |
11/80 |
Peak |
140.52 |
2.73 |
62% |
|
|
|
8/82 |
Trough |
102.42 |
|
|
1.70 |
-27% |
4.44 |
8/87 |
Peak |
336.77 |
5.03 |
229% |
|
|
|
12/87 |
Trough |
223.93 |
|
|
.28 |
-34% |
5.31 |
7/90 |
Peak |
368.95 |
2.61 |
65% |
|
|
|
10/90 |
Trough |
295.46 |
|
|
.24 |
-20% |
2.85 |
2/94 |
Peak |
482.00 |
3.31 |
|
|
|
|
4/94 |
Trough |
438.92 |
|
|
.17 |
-9 |
3.48 |
7/98 |
Peak |
1186.74 |
4.25 |
170% |
|
|
|
8/98 |
Trough |
957.28 |
|
|
.08 |
-19% |
4.30 |
3/00 |
Peak |
1527.45 |
1.58 |
60% |
|
|
|
10/02 |
Trough |
776.75 |
|
|
2.5 |
-26% |
4.02 |
|
|
|
|
|
|
|
|
Averages |
|
|
3.08 yrs |
93% |
0.94 yrs |
-26.4% |
4.02 |
From the table it is evident that every four years is when we see a full cycle in the market. It is seen that bull markets were the dominant trend every three years followed by a bear market, which was observed for almost a year. In comparison to the presidential election data it is seen that the lows in the stock market have been the case close to the congressional elections that take place mid-year or say two years before the Presidential elections. This has been a commonly observed phenomenon over the years.
Table 2: Presidential Elections and Market Troughs
|
|
Year During |
1942 – 1944 |
4/42 |
2nd Year |
1945 – 1948 |
10/46 |
2nd Year |
1949 – 1952 |
6/49 |
1st Year |
1953 -- 1956 |
9/53 |
1st Year |
1957 – 1960 |
10/57 |
1st Year |
1961 – 1964 |
6/62 |
2nd Year |
1965 – 1968 |
10/66 |
2nd Year |
1969 – 1972 |
5/70 |
2nd Year |
1973 – 1976 |
10/74 |
2nd Year |
1977 – 1980 |
3/78 |
2nd Year |
1981 – 1984 |
8/82 |
2nd Year |
1985 – 1988 |
12/87 |
3rd Year |
1989 – 1992 |
10/90 |
2nd Year |
1993 – 1996 |
4/94 |
2nd Year |
1997 – 2000 |
8/98 |
2nd Year |
2001 – 2004 |
10/02 |
2nd Year |
|
|
Average = 1.87 years into presidential term |
The above table makes it clear that the low period or the bearish trend is a feature witnessed approximately at the time of the congressional elections or say two years before the Presidential elections.
The Suggested Investment Strategies
Analyzing the price data for the S&P 500 Index shows that for an investment strategy that would definitely bear good results, the thing to do is to buy stocks on the 1st of October two years before the Presidential elections and to make a sale on the 31st of December on the fourth year. This is the best way to outwit the market and to make the most of it. The bare markets (which is said to be the case when the market falls by 15% or more for about one to three years) has been seen to be the case in the first or second year after the Presidential election whereas the bull market (or the market with rising prices) is the case close to the Presidential election.
There are also other macro factors affecting the market, therefore, even though the trend observed is the same very year the duration of each phase varies from time to time. So is seen the case where some of the cycles have been long whereas others short like from 1946-1949 has been short as compared to 1982-1987 which was observed to be longer.
A Case Study
With the available facts it is derived that the S&P 500 Index dips every two years after the Presidential elections, based on this we can conduct a hypothetical test taking the case of two investors and see the return they get on their investment with two different investment strategies.
The dividend and interest earnings are not taken into account. For simplifying calculations, the taxes and commissions if any are not taken into account. This phenomenon of a direct relation between the Presidential elections and the stock market has been observed only after the year 1952 and therefore the period taken into account starts from the Presidential election of 1952.
Let us take the first case where we assume that the first investor has been buying the S&P 500 Index 27 months prior to the Presidential elections and sold out all that he had on the 31st of December in the year of the Presidential election. The period of 27 months was taken as it was seen that this would be a period, which would have better returns on the investment.
On the other hand, we assume that the second investor or Investor 2 has bought the S&P 500 on the very first trading day of the first year of the Presidential election and sold all he had on the 30th of September in the second year after the Presidential elections. Now we will see as to who has made a considerable profit on his investment and which the better investment strategy is.
Table 3: Percentage and Dollar Returns of Two Investment Strategies (Dollars Amounts are Cumulative), Starting Value for Investors 1 and 2 = $1,000
|
Percent Change from Oct 1 of 2nd yr of Presidential term through Dec. 31 of election yr. (Investor 1 strategy) |
Percent Change from Jan. 1 of inaugural yr through Sept. 30 of second yr of presidential term (Investor 2 strategy) |
|
|
1952 |
+35% |
+22% |
$1,350 |
$1,220 |
1956 |
+45% |
+8% |
$1,956 |
$1,318 |
1960 |
+16% |
-2% |
$2,271 |
$1,291 |
1964 |
+52% |
-9% |
$3,451 |
$1,175 |
1968 |
+39% |
-19% |
$4,798 |
$952 |
1972 |
+40% |
-47% |
$6,717 |
$505 |
1976 |
+70% |
-4% |
$11,418 |
$483 |
1980 |
+32% |
-12% |
$15,072 |
$425 |
1984 |
+37% |
+40% |
$20,649 |
$595 |
1988 |
+19% |
+11% |
$24,571 |
$660 |
1992 |
+38% |
+7% |
$33,909 |
$707 |
1996 |
+60% |
+42% |
$54,254 |
$1,004 |
2000 |
+34% |
-36% |
$72,701 |
$643 |
The observations from the table go to show that the first investor or investor1did not loose any of his money on the investments and his profits saw a rise of ranging from 70% before the 1976 elections to about 16% before the election in the year 1960. The investments of $1000 grew to $72701.
The second investor on the other hand did not have only profits and his highest loss of -36% was recorded in the year 2000 after the Presidential election. His original investment at the end of the same period was reduced to $643. This does not include the fluctuations in the inflation rate and its effects on the economy.
Putting this in the form of a graph goes to make the difference in the two investment strategies very evident.
Taking into account the cumulative dollar difference shows that the difference between the two investment strategies is quite a bit.
Conclusion
The study has been successful in identifying a market cycle making use of which the investor can reap rich dividends. The best time to invest as per the study is about 27 months before Presidential elections as compared to after the Presidential election.
However there are other results and patterns that have been observed in the study. Like for example the years such as 1905, 1915… that ended with 5 showed profitability. The year 2005 is the first or inaugural year and equipped with this information and understanding of the market one can definitely make some interesting investments strategies.