One of the more fascinating patterns in markets is the tendency for outsized returns in the third and fourth year of the presidential cycle relative to the first and second.
The story makes sense for the third year (pre-election year), as the incumbent wants to get reelected or have the party in good standing (if it is the second term) for the campaigning of the fourth year. People feel good when employment is high and income is growing, along with their brokerage statements and 401(k) plans. What better way to help morale and get reelected than by using simulative policy to help the stock market along.
The calendar year of 2013 did not conform to the first year pattern with its outsized gains. Today we are in the second year of the term, which typically has median returns of 6.9% and is negative 38% of the time, both worse than long-term averages. The third year, on the other hand, was up every year since 1949 with a median gain of nearly 19%.
Not all trends are in the executive branch's favor today though. Another telling statement from this week's Fed meeting came in a press release stating that "Fiscal policy is restraining economic growth, although the extent of restraint is diminishing." For several meetings in a row, the Fed nodded to fiscal policy, essentially saying Congress is really holding back growth.
This could be a reason why President Obama's State of the Union speech alluded to his "with or without Congress" approach to the economy, among other issues. Although fiscal policy is easing, Americans are still feeling the pinch with tax receipts at record highs and savings rates near the lows of the last decade.
Now we really do not care much for the politics, but we mention this to try to glean insight on how policy could change over the next 12 to 24 months and its effect on the economy and asset prices.
Most consider the presidential cycle to start in the fourth quarter since that is when elections occur. Although the cycle is going against the stock market currently with a sluggish start to 2014, historically in the fourth quarter, the trend changes. Since 1930 in the fourth quarter of mid-term election years, the stock market was up 18 times out of 21 for a median gain of 8%. Not bad for three months.
Volatile markets may continue for the first nine months of 2014, due to a variety of factors from market participants finally recognizing the weakness of certain Emerging Markets, changing monetary policy from the Fed, or just mean reversion. Odds favor a light at the end of the tunnel. Still, if this pattern worked all of the time, there would be no need to do any other analysis. While it is an interesting exercise to look back at the past, monitoring valuation, trend, and fundamentals are the most important factors.
For more information about how the Presidential Cycle affects the stock market, feel free to contact one of our wealth management advisors at 440-605-1900 or leave a comment below. Stay up to date – follow us on Twitter @aurumwealth and to receive weekly investment-related updates, sign up for our free newsletter.
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