If you keep up with investing news, you might have heard that the second year of the presidential election cycle could mean bad news for the stock market. If you’re new to investing and you haven’t learned everything about the financial world, you might be wondering what this “presidential election cycle” theory is all about, how it could potentially affect your investments, and why you need to know about it. 

This article will explain what the “presidential election theory” is, why the second year of a presidential term is so vital, and what you can expect to happen in the market. Now, without further ado, let’s get started. 

What’s the Presidential Election Theory? 

The market phenomenon of the so-called presidential election cycle theory was first suggested by the founder of the Stock Trader’s Almanac, Yale Hirsch. The idea is that the equity market returns can be predicted with the same pattern each time a new president of the United States gets elected. If you follow Hirsch’s theory, you will come to the conclusion that the stock market in the U.S. performs the worst during the first year of the election, peaks in the third year, and falls again in the final year of the president’s term. At this point, the whole cycle is set to start all over again after the next election. 

More About the Presidential Election Cycle Theory 

When the first edition of the Stock Trader’s Almanac was published by Yale Hirsch, it quickly became widely used by fund managers and traders, who were hoping that the timing of the market would help them get higher returns. Hirsch’s almanac introduced many well-regarded theories, one of the most famous being the “Santa Claus Rally,” which is widely influential.

The “Presidental Election Theory” is another one of Hirsch’s theories, and he used data going back several decades to make his point. In this theory, he claimed that the first two years of a presidency were the worst for stock performance. However, in the current political climate and in light of the historical data that we currently have, many investors have started to doubt the accuracy of this theory.

The Theory vs. the Historical Data 

The whole idea behind the presidential election cycle is that presidents and the political party they represent are always trying their best to get re-elected. Therefore, the notion is that they will be more willing to make difficult economic decisions early on in their terms so that by the time they have to be re-elected, the economy will be back to its peak performance. On paper, this idea sounds both logical and realistic, but what happens when we compare it to the actual data that we have for the U.S. stock market? 

Before we answer that question, let’s first establish the idea that there are many different factors that may influence the performance of the stock market in a given year, and some of them are completely unrelated to the President or Congress. For example, consider how many factors have affected the market over the past several years and months—a global pandemic and the invasion of Ukraine, among other events—which have caused enormous economic fluctuations.

With that said, when taking a look at all data from the past several decades, we can clearly see that there’s a tendency for stock prices to fluctuate semi-consistently throughout the four-year presidential term. In 2016, Schwab Centre for Financial Research conducted an analysis of the market going back to 1950. They found that during the third year of the presidential term, the average stock market gains are undoubtedly the highest compared to other years.

Though this doesn’t provide unquestionable proof, we can also look at it in a different way. The stock market had gains in almost three-fourths of the calendar years between 1950 and 2019. The S&P 500 data for presidential terms’ third years shows that there was an annual increase 88% of the time, compared to an average of about 60% of the time during the first two years of a presidential term. This is another piece of evidence that suggests Hirsch was at least partially correct in his presidential cycle theory.

Of course, each rule has its exceptions. In this case, the recent presidency of Donald Trump was an outlier, as the market didn’t experience the first-year slump as predicted by Hirsch’s theory. During his first year, he saw the S&P 500 rise by 19.4%, and while there was a slump in his second year, the third one was exceptionally strong for the market, and the S&P had a surge of 28.9%.

Is the Presidential Election Cycle Theory Always Reliable? 

The predictive power of Hirsch’s theory can only be described as mixed. While it’s true that the market usually slows down during the first two years of a presidential term, the direction of the stock prices hasn’t been consistent from one election cycle to the next. However, the third year being the strongest is a far more reliable trend, as the average gains are exceeding those of the other years.

With all that said, saying that investors should follow Hirsch’s theory blindly is stretching it. While there’s some consistency between the data and the theory, the reality is that there have been fewer than 20 elections since the 1950s, and there’s not enough data from which to draw proper conclusions. 

Even if we take two correlated variables, such as the election cycle and the market performance, that doesn’t necessarily mean that there’s any causation between them. The classic phrase “correlation does not imply causation” is an important lesson for all investors to keep in mind when choosing their strategies.

It could very well turn out that the market tends to surge during the third year of the presidential cycle for reasons that have nothing to do with the presidency or the election timeline. The theory largely relies on the estimation of the power of the president, while the reality is that the stock market is greatly influenced by a large number of factors that have nothing to do with the White House. 

Along with that, as the world becomes more global and connected, the power of the president over the U.S. economy decreases. Natural disasters and political events in other countries and continents can affect the stock market much more than a presidential decision, as we can see clearly from the past three years.

Should You Be Mindful About the Second Year of a Presidential Term? 

As already mentioned, any aspiring investor should be aware of the presidential election cycle theory; however, you shouldn’t blindly trust in it. While it’s a fact that for most recent presidents, the second year has been less unsuccessful in terms of stock market returns, those prices are also very likely to be affected by events that happen outside the United States and outside the President’s scope. That’s why our advice is to not blindly panic because it’s the second year of the term, and instead take a realistic look at what’s happening in the world and make your decisions based on that. 

Each theory can be useful in its own way. However, when it comes to making financial decisions, you should always consider all your options and the current political and economic climate instead of counting on a trend that can easily fluctuate and change. 

As always, if you need any help navigating your finances and investments, Alpha Wealth Funds is ready to help. We know the endless investment theories and strategies are exciting to learn about, but they can also be overwhelming. Our team of specialists can give you the necessary guidance and knowledge you need to grow your wealth and keep your finances secure.

Please feel free to reach out to me on this or any of your investment needs or questions. I may not always have the answers at my fingertips, but I promise I will get them for you. Michael Torrence

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Michael Torrence – Investment Advisor Representative: Michael was born and raised in Ohio and attended The Ohio State University. After College, he was commissioned as a 2ndLt in the United States Marine Corps. He attended his initial training in Quantico, Virginia, then graduated at the top of his Primary Aviator Class and was selected for the Strike (Jet) Platform.

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