Wall Street Down on the Week – What does Election Year Mean to Our Economy? -FROM BEACON EQUITY RESEARCH

 

Weekly Commentary 

The Vote: What Decision ‘08 Means to Your Investment Portfolio

In my last newsletter I outlined the seasonal cycles of the market. In light of a sea of blue and red partisan flags waving in the Democratic and Republican National Conventions, it only seems fitting to outline how the presidential election correlates with the stock market.

Ignorant to the governing bodies of our nation, some people point a blame-laced finger at the president of the United States for our economic woes. While he does have some influence over the economy through the trickle down of taxation, legislation, world affairs and other factors, the Federal Reserve holds the monetary reigns as far as the market is concerned; the executive branch has little influence in those matters.

Still, the Presidential Election Cycle theory is widespread, though more for its cyclical history than actions of the chief executive. The departing administration’s spending patterns and track record, as well as the intentions of the new administration in regards to taxation and economic platform create an observable pattern beginning in 1942.

From 1942 until 2006, 16 market cycles have occurred in four-year patterns. Generally, stock market lows occur about two years before presidential elections. After the ballots are counted, the bulls run for about three years, and the bears roam for about one.

The first year following an election is generally low, picking up in the late second or third year when the investment community has had a chance to pick up on consistencies and predictions in administrative actions, spurring investor confidence based on campaign platform promises.  But after a positive run, during election year, things usually take a downturn. Stock prices follow corporate earnings, and as the new policies and programs give way to more taxes and government spending, affecting businesses, the stocks go down.

Still, unpredicted macro events, such as those from foreign affairs, natural disasters and economic storms (think housing crunch) can affect the cycle, making the assumption as to the length of the cycles risky if you’re betting your portfolio on it.

But with all the theories, patterns and cycles out there, how much merit does this one carry? Though the lack of scientific basis leaves the theory highly questionable, it’s surprisingly accurate. One low that was off course can be attributed to Black Monday of October 1987, which happened in the third term of the presidency. And two exceptions to the high swing was the fall in the market Immediately after World War I and during the resignation of U.S. President Nixon in the final term.

This notion has spurred much research and speculation over the years, most of it based on the S&P 500. According to a 2004 study by Marshall Nickles, an economics professor at Pepperdine University, it is profitable for investors to be more aggressive in years three and four of a presidential cycle.

Data going back as far as 1952 supports Nickles’ study; Nickels illustrates with an investment of $1,000. He found that if an investor pumped $1,000 into the S&P 500 on October 1 of the second year of the four-year cycle (when stocks typically bottom), and sold out on December 31 of the election year, his investment would have grown to $72,701 in 13 election cycles. Accordingly, investments of $1,000 on January 1 of the inaugural year, sold on September 30 of the second year of the presidential term would have suffered losses of $357 in seven of those 13 cycles.

Jim Stack, InvsTech Market Analyst said in an article, "Basically, it boils down to just 'good politics.' Politicians worth their salt understand the goal: get any bad economic news over early during your term and have the economy back on track and humming along by Election Day.

"Consequently, the worst stock market performance typically occurs in the first two years after a Presidential Election. The third year, as politicians begin gearing up for re-election, is usually the
best year on Wall Street by a wide margin, and the only year where the average gain in the S&P 500 tops 10%.”

Though history tends to repeat itself, it’s nearly impossible to forecast the market no matter what method you’re using. The evident pattern can easily be swayed as we’re in the midst of a recession paired with a drowning financial industry, lagging consumer spending and the rest of the bunch.

But we’re 58 days away from casting ballots and just around the corner from putting this theory to the test.

At the closing bell Friday the Dow secured a slight gain, pulling 32.24 points to close at 11,220.47; Nasdaq lost 3.16 points, settling at 2,255.88; and the S&P 500 gained 5.45 points to finish this week’s session at 1,242.28.