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Election Years Can Be Good Years for the Markets

Perhaps it's a testament to the persuasion of those snappy campaign slogans, dazzling smiles, and brightly colored bumper stickers. But experienced investors may be getting excited for the first Tuesday in November. They know that for more than half a century, stock prices have soared during election years.

This is an old piece of Wall Street wisdom that actually has some consistency to it, because it is based on a sequence of events that is almost predictable.

Let's take a look at the political cycle of a newly-elected, or re-elected, president. During the months before an election, the candidates are nominated and investor-voters are, depending on who's running, hopeful that their candidate will get—or keep—his job. After the inaugural, for the first 100 days of an administration, our chief executive enjoys a honeymoon period with the press and Congress. He or she gets a chance to settle into the job (or get back to work), and the American public gets to bask in the president's infectious optimism about the country's future for a little while longer. Then, the first two years of the presidential term are used to make unpopular decisions and to be an outlet for bad news.

If you are skeptical about the consistency of this phenomenon, all you have to do is look at the statistics: nine of the past thirteen recessions in the U.S. have begun during the president's first year in office.

Since World War II, the stock market has never posted a negative annual return in a pre-election year. In fact, the stock market has posted an average annual return of 9.5 percent in the first year of a presidential term, 8.1 percent in the second year, 21.3 percent in the third year, and 12.2 percent in the fourth year. You may ask, “Why are the numbers so much higher in the third year?”

The reason for this big increase is that, typically, presidents use their third year in office to either cut taxes or to increase spending in a last-ditch attempt to stimulate the economy and increase their chances for re-election.

If we were to do a historical analysis of market fluctuations during the three-month period surrounding presidential elections, it would show us that the market consistently gets stronger as Election Day approaches. In fact, within the past 112 years, there have been only three instances in which, during this three-month period, the Dow failed to hit or come within 5 percent of the year's high.

This growth is especially apparent when the incumbent runs for re-election. If you've ever felt that your decision to vote for a particular candidate was based almost entirely on your financial situation rather than on his campaign platform, you're not alone. Wall Street—and savvy politicians—know that people do vote with their pocketbooks. The idea is that investors tend to react negatively to the potential uncertainty that a new president may represent. So the incumbent provides hope for continued prosperity.

But even if the incumbent has a very low approval rating, market growth is still likely to occur because investors become optimistic about the prospect of a new presidential administration.

While the election cycle remains strongly tied to market performance, this does not mean that you should plan your investment strategy according to the most recent polls. More often than not, the president's approval rating is a function of the country's underlying economic condition.

Put another way, America's confidence in the president is typically caused by high stock prices—making it much easier to predict the outcome of the election based on the stock market than the other way around. Elections are, after all, short-term events, and your investment process should be based on a long-term strategy—regardless of how dazzling those returns look on the financial pages. Of course, your financial professional can best provide you with the assistance you may need.

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Jane Taubner Barney is a financial advisor with Canby Financial Advisors in Framingham. She offers securities and advisory services as a registered representative of Commonwealth Financial Network—a registered investment advisor and member firm of the NASD/SIPC. She may be reached at (508) 820-7921 or at jbarney@canbyfinancial.com.