As President Obama gears up for his penultimate year in office, it could be time to cast a ballot for stocks.
That suggestion has nothing to do with the administration’s policies or whether investors agree with them. Rather, it’s about history.
Specifically, we’re talking about the so-called presidential stock cycle, which suggests that stocks do better on average in the president’s third year in office (regardless of whether it is a first or second term) than in any other year. The pattern has held with remarkable consistency.
Since 1900, the S&P 500 has rallied an average 10.7%, excluding dividends, in the president’s third year, compared with a gain of 4.1% to 7.8%, on average, in the other years, according to an analysis provided by S&P Capital IQ. What’s more, returns in the third year were positive 75% of the time. A look at the data back to 1945 shows a similar pattern.
Why does this happen? The theory says that tough legislation typically is forced through in the first two years of a presidency, when the incumbent is still riding the victory wave. The 2010 Affordable Care Act is an example of this phenomenon.
As for the third and fourth years, the idea is that the officeholder starts to do whatever is necessary to really boost the economy in an effort to get re-elected. The data show that during those periods, policies have been most dovish or pro-growth, says Mebane Faber, at El Segundo, Calif.-based Cambria Investment Management. With second-term presidents the logic is weaker, but it’s still arguable that they will try to boost growth to help their party in the next election.
The S&P Capital IQ data show that the third-year market rally is front-loaded, with eight percentage points of the 10.7% gain coming in the first half of the year, on average.
Of course, just because there is a tendency for things to happen a certain way doesn’t guarantee that they will—especially with a second-term president. After all, 75% positive returns means that returns were flat or negative 25% of the time.
And this time around, what the government can do to help the economy may be limited, says Jack Ablin, chief investment officer at BMO Private Bank in Chicago.
“There isn’t a lot of ammo left with interest rates already at zero, and we are running fiscal deficits in the hundreds of billions of dollars,” he says. “All the stops are already out.” In other words, the Federal Reserve can’t make the cost of borrowing much lower, and the federal government probably won’t borrow more to stimulate growth.
Still, there might be hope for a third-year jump in stocks.
“The president is a lame duck, and if he really does want to end his office on a higher note then he is better off working with the Republicans,” says Sam Stovall, U.S. equity strategist at S&P Capital IQ in New York. He points to tax overhaul and approval to complete the Keystone oil pipeline as areas that might see progress.
Tax overhaul might cause a “surge of business confidence” as corporations decide to put their increasingly large cash balances to work, he says. And a completed pipeline could increase supplies of energy to the country, lowering prices.
Still, he adds, “it would have to be in 2015. Nothing will likely get approved in the election year,” as both sides duke it out for votes.
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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
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