In the coming months we will be publishing a three-part series about presidential elections, the performance of the stock market, and investors’ feelings of heightened risk in election years. In Part One we address the overstated notion of the “Presidential Cycle.”
There has long been a perception that the four-year presidential cycle influences stock market returns. Editor and founder of the Stock Trader’s Almanac Yale Hirsch developed the theory of the “Presidential Cycle,” writing in the 1967 edition, “Presidential elections every four years have a profound impact on the economy and the stock market. Wars, recessions, and bear markets tend to start or occur in the first half of the term and bull markets, in the latter half.” The theory proposes that:
The market is weakest in first two years of a presidential term as the newly elected president acts to fulfill campaign promises that cater to special interest groups and may not be market friendly.
The third and fourth year is marked by a shift. The president has less incentive to introduce new policy and is more motivated to ensure the economy is running smoothly when the next election comes around. Thus, stock market returns are stronger in the latter two years of a presidential term.
In reality, since 1950 the S&P 500 has, on average, produced a fairly constant return over presidential cycles. There has been no dip in the first two years as Hirsch predicted. However, there has been a tendency to see outsized returns in the third year of a presidency. So, Hirsch’s prediction of a jump in the market in the latter half of a presidency appears to be partly true, at least when looking at the averages.
It is important to remember that historical patterns are not written in stone. For example, President Trump’s tenure is a clear exception to past trends. In the first year of his presidency there was a 22% total return for the stock market as investors anticipated the introduction of market friendly initiatives. Strong performance in the first year of a presidential term does not fall in line with what is expected in Hirsch’s theory. Policy tightening from the Federal Reserve (not Congress or the President) led to a -4.4% loss in the second year. Once again, neither presidential nor congressional policy made a material impact on overall market returns. In the third year, easing of monetary policy was partly responsible for a 32% return. This fourth year will, of course, be marred by the COVID-19 pandemic. The influences of the business cycle, monetary policy and unexpected events all played important roles in determining outcomes. In essence, the market returns over the last four years cannot be explained by the presidential cycle.
A final observation relates to returns experienced in the 4th year of a president’s term. Many investors are on edge as they speculate how future policy initiatives and social unrest will impact the country. However, we have seen heightened election year uncertainty before, and the market still thrived. For example, the 1952 election of Eisenhower was overshadowed by failed Korean War truce talks (S&P 500 up 12%); the 1964 election of Lyndon Johnson saw the country mired in civil rights unrest (S&P 500 up 13%); during Jimmy Carter’s election in 1976 the economy was in a recession (S&P 500 up 19%); in 1988 George H.W. Bush was elected amid the Savings & Loan crisis (S&P 500 up 12%), etc. In the end, investors believe that the American economic engine will continue to chug along regardless of which party’s candidate becomes president.
In the next article in this series, we will discuss why neither Democratic nor Republican presidents have historically produced superior stock market returns.
 Yale Hirsch and Jeffrey Hirsch, “The Stock Trader’s Almanac 2004”, where he reiterates his view of the presidential cycle.