Do Presidential Elections Predict Market Performance?
Behavioral finance, which studies the effect of psychology on investors and markets, has identified a phenomenon called heuristics. It’s what happens when individuals develop rules of thumb for investing; mental shortcuts that are intended to help simplify and manage the avalanche of market and economic data available. During the last year, a variety of publications have offered election year heuristics that link politics to market performance. These theories include:
The Presidential Election Cycle postulates that U.S. stock markets are weakest in the year following the election of a new U.S. president, no matter which party wins. After the first year, the market improves until the cycle begins again with the next presidential election. While the shortcut appears to prove out when performance numbers are averaged, it doesn’t hold true when performance is examined on a year-by-year basis, as shown in the chart. If an investor attempted to time the markets using this rule of thumb, he or she might be disappointed with the results.
Presidential party affiliation has also been examined as a predictor of market performance. An article published in the Journal of Finance in 2003 suggested that large company stocks had gained 9% more on average1 during Democratic administrations from 1927 through 1998.2 The following year, the Federal Reserve published a rebuttal which found the difference to be much smaller and fluctuate substantially over sub-samples.3 Other pundits have calculated market performance when the President, House, and Senate have shared or divided political affiliations. Some have reported that performance is best when Republicans are in control of all three, an alignment occurring for 11 years from 1925 through 2008.4 And that highlights another critical issue with election year heuristics: the sample size is very small for almost every calculation made to support a position.
Anyone who remembers headlines like Dewey Beats Truman or Supreme Court strikes down individual mandate portion of health care law knows that predicting the future is difficult. As an investor, it’s essential to recognize that the drivers behind market performance include economic factors, investor sentiment, and underlying company fundamentals. There is only one rule of thumb that we recommend following: Nothing beats good research, having the right balance, and long-term focus.