The stock market is chock-full of patterns and theories that drive investment decisions like “sell-in-May-and-go-away,” the “Santa Claus rally,” and so on. Another popular pattern theory relates to how stocks perform during an election cycle. With the presidential election coming this year, it’s worth taking a look at how stocks have done historically in the fourth year of a president’s term.
Election Year Background
In “theory,” the year following an election year is the weakest for stock market performance. In my view, it makes sense why – it is typically the one where the sitting president is most aggressive about policy setting. The result is that markets get agitated when there’s a higher probability of regulatory, tax or property rights rules changing.
But, as a president moves deeper into their term, the likelihood of passing big, sweeping legislation falls. Congressional seats of the president’s party are historically lost in the back half of the term and Congress has been known to stalemate on many big issues – pushing them off to the next president’s first term. It’s what we’re seeing now.
It follows that, historically, stock performance has been the strongest in the third year of a president’s term and above average in the fourth. Investors should not take this as an indicator that stocks are poised to do well this year – fundamental economic trends and corporate earnings still carry the most influence, in my view. But, the fact that it’s a presidential election year should be taken as a net positive for the market’s chances this year. It’s another tailwind that isn’t likely to work against the market.
Indeed, in the last 22 election years there have only been only four where the S&P 500 index finished negative:
I see two takeaways from this data. The first is that the negative election years almost always occurred when there was already a recession fully in progress. The second is that 2008 feels like an outlier, a version of the “100 year storm” that, to me, we are not likely to see to that extent again for some time.
And, the other negative election years weren’t drastically negative. Losing 10% is difficult and undesirable for everyone, but it’s not life-changing. Five of the last seven years have returned excess of 10%, sometimes much more.
Bottom Line for Investors
Again, I think the ‘election year indicator’ should more or less be taken as something you’d put in the “positive” column if you were making a list of factors that could either work for or against the market. In other words, while it might help drive some positive returns, I don’t see a scenario where it hurts them. Regardless, I’d stay focused on fundamentals and corporate earnings as the real drivers of performance, which I think are positive going into the New Year.
Disclosure