Do stocks always rise in a presidential election year?
Someone told me yesterday that he was moving into the market because stocks always rise during a presidential election year. You may also be hearing this prediction from friends and co-workers, and might be wondering if you should move more money into stocks based on this trend. Well, here are some key lessons from this theory:
The facts
According to Ned Davis Research, between 1900 and 2009, stocks have turned in their best performance during the last two years of a presidential election cycle. The average returns of the Dow have been 5.5 percent in year one, 3.7 percent in year two, 12.6 percent in year 3, and 7.5 percent in year four. Thus, applying this theory, 2012 would be a good year for stock investing.
I looked for some academic research and was able to find a paper from 2007 noting the results were statistically significant, especially during the past four decades. The paper stated that this was a market anomaly that could be useful for investors. I saw very little explanation for this so called anomaly.
My analysis
No question, I'm the ultimate stock market "theory" skeptic, so before I put more money in stocks, I checked out the Dow returns in this presidential cycle. As it happens, this theory has not proven to be such a good predictor, as the worst two years of the cycle -- years one and two -- clocked in double-digit returns. Year three (2011), the historic best year for stocks, turned in only 5.5 percent for the Dow. Worse yet, the Dow is only 30 stocks and not even weighted by size. The total return for U.S. stocks, including dividends, was just under 1.0 percent in 2011, as measured by the Wilshire 5000.
Though we don't yet know how Year Four under President Obama will turn out, we can go back to 2008 and look at Year Four under Bush. Instead of going up, the Dow lost 33.8 percent in 2008. I suspect that if the 2007 paper were updated, the statistically significant conclusion would have vaporized.
Key lessons
I think there are two key lessons from this theory that influenced my friend's investing. First, human beings are pre-programmed to finds patterns out of randomness. In reality, the math works out that if we regress stocks against 1,000 random events, we will on average find one that gives us a 99.9% chance of correlation. Unfortunately, it will have no predictive ability going forward. Butter production in Bangladesh had the highest correlation to stocks of any regression ever published.
Superbowl predicts stocks
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The second lesson is that human beings have the ability to believe anything they want to believe. My friend had conveniently blocked out the painful 2008 financial markets disaster and was ready to bet the farm on a theory that would have taken only a few minutes to check out.
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If the incumbent wins in November, then it is business as usual really quick, right after the election. If another party takes over the whitehouse, then it can take from November to the next June to get back to making some money.
All businesses like to know what the rules of the game are going to be before they place their bets. If Obama wins, the market will pick up and rally at the end of the year. You don't even have to like the man or his policies to understand that. Businesses already know where he stands on health care, what wars he wold have us in and what he generally thinks about taxes, debt, small businesses, banking, etc.
A new president will slow down the market for 12 months (June to June) because we will have to figure out all over again what the new guy wants done and what he actually can get done and what that means for us.
Businesses will hold tight to their money this year and not make any major investments from June to November.
If this were true and predictive, the last thing you'd want to do is tell people. You could be a billionaire!
Always great to hear from you. The herd is usually wrong, but not always. Occasional rebalanicng is all you need so I'm in 100% agreement.
I predict 99% of the 2012 predictions will be wrong and cause people to lose money.
Have you ever thought of writing a blog?
Always great to hear from you. The herd is usually wrong, but not always. Occasional rebalanicng is all you need so I'm in 100% agreement.
I predict 99% of the 2012 pedictions will be wrong and cause people to lose money.
Have you ever thought of writing a blog?
You didn't mention one important stock market indicator, human psychology. Remember Warren Buffett's advice on being greedy when others are fearful. There is a CBS/Moneywatch article from Jan. 11 titled "Investors flock to savings, checking accounts". It states that there was a lot more money stashed in low interest bank accounts (~$900B) versus stocks (~$110B) in 2011. There's "fearful"... When people start to relax, forget the lessons of 2008 (and 2002, 1987, 1973 & 1929...), and decide to speculate (vice invest), I think much of that money will flood back into stocks. We'll probably see a good bump up in stock prices in the next couple of years, whether or not it is an election year.
Does this mean that I will go for broke and throw everything I have into stocks today? Does this mean I am swelling with hubris and "advising" you or anyone else to do so? Nope and nope. I rebalanced last summer, and am in no rush to do so soon. Besides, I could be wrong. Something else might happen to scare the sweaty herd of bull, bear, lemming, and for all I know, ostrich investors (and speculators & day traders). I'm just amusing myself with this unpatented crystal ball prediction, and hopefully make a little money by staying invested as usual. regards,
Jerry