What is the Presidential Cycle?
The Presidential Cycle is a theory that suggests that the United States stock market experiences a decline in the first year a new president takes office. The theory was first developed by Yale Hirsch, a stock market historian. It suggests that the US presidential elections exert a predictable effect on the economy. According to the theory, the stock market starts to improve in the second year after the Presidential election.
Hirsch’s theory was shown valid for most of the 20th century. Some investors even used the presidential cycle as a market timing indicator for the stock market. However, it has since lost its predictive power. In the 21st century, the stock market has surged in the initial year of Presidencies. The S&P 500 index rose in the first years of the Trump, Bush, and Obama Administrations.
The Reasoning behind the Presidential Cycle
Hirsch offered his reasoning on why the election of a new President affects stock market performance.
When the president is elected, he/she has to work towards fulfilling their election promises. This may include taking actions that have a negative effect on the market.
In the third and fourth year of a Presidency, a sitting president will start campaigning again. Having a strong economy is a great way to get votes. Therefore, the President is likely to prioritize programs that aim to heat up the economy. If such programs succeed, this may logically have a positive effect on the stock market.
Is the Cycle Accurate?
Past history of the stock market’s performance shows that there is some validity for using the Presidential cycle as a stock market indicator. However, the cycle has proven unreliable as an indicator in the early 21st century. Therefore, investors are advised against using the Presidential cycle as a standalone indicator. Instead, they should consider other factors that may potentially influence economic and market conditions.
In addition, the US President lacks the power to control what happens in the global political environment. Certainly, actions by the President or Congress may affect the financial markets.
The timing of the President’s term relative to the stock market is just one of the factors influencing market risk. Other factors may include investor psychology, interest rates, and the performance of the global economy.
Case Study: Performance of the S&P 500 during Presidential Election Cycles
The Schwab Center for Financial Research analyzed the S&P 500 market performance from 1950 to 2015 to determine how closely market performance correlated with the Presidential cycles. The study looked at 16 election cycles, in which the first year of the cycle coincides with the first year of the US President’s term. It revealed that in nine of the 16 cycles analyzed, the index finished lower than the rest of the years in a President’s term.
The third year of the cycle was the best year for equities, rising in all but two of the 16 cycles analyzed, and showing an average return of 16.4%. The last year of the cycle, which is also the next election year, was also found to have been good for equities. Overall, stocks rose in 81% of the cycles analyzed, delivering an average return of 6.6%.
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