No one can time the stock market, but that doesn’t mean investors haven’t tried over the years. With the 2020 election occurring in an unprecedented year for both the stock market and economy, Yale Hirsch’s Presidential Election Cycle theory came back into the spotlight. While Hirsch’s theory has fallen out of practice since the 20th century, some speculate that it hasn’t entirely lost its usefulness.
According to Hirsch, stock markets in the United States are at their most weakened condition the year after a presidential election. The theory goes as follows: The market recuperates after the first year, reaches a high point during the third year, and falls again during the fourth year of the presidential term — thus beginning the cycle all over again with the next presidential election.
Understanding The Presidential Election Cycle Theory
Yale Hirsch published the Stock Trader’s Almanac, first edition, in 1967. It quickly became the guidebook, and a popular tool, for day traders and fund managers wanting to boost their returns by timing the market. In this book, Hirsch also introduced two other influential theories: the “Santa Claus Rally” and the “Best Six Months.”
The “Santa Claus Rally” happens in the last week of December and continues through the first two trading days in January. It is a sustained rise in the stock market during that time. The “Best Six Months” hypothesis or the “Halloween Strategy” states that it is best to purchase stocks in November and hold them until April when it is time to sell. In other words, it supports the theory that the stock market takes a dip during the summer and fall months.
Hirsch’s findings also included the belief that the four-year presidential election cycle was an exact gauge of stock market performance. According to Hirsch, stock market performance is weakest during the new administration’s first two years. That’s because the president focuses on his central policies and returns the favor to special interest groups that helped him win the election.
As the next election approaches, the theory suggests that the president shifts his focus onto fortifying the economy to get re-elected.
Historical Market Performance
Many factors can impact the stock market’s performance in any given year besides Congress or the president. Data over the last several decades suggests that as an election approaches, share prices increase.
According to Charles Schwab, who studied the market data going back to 1950, the third year of the presidency overlaps the strongest with market gains. Take a look at the following average returns for the S&P 500 in each year of the presidential cycle:
- First-year returns: +6.5%
- Second-year returns: +7.0%
- Third-year returns: +16.4%
- Fourth-year returns: +6.6%
Since 1950, the average annual rate of return for the S&P 500 has hovered around 10.82%. As Hirsch predicted, it appears that the third year does increase and peak. So how reliable is the presidential election cycle theory? From 1950 to 2019, you can see that the stock market experienced gains in 73% of the calendar years. However, the S&P 500 experienced an annual increase of 88% during year three of the presidential election cycle.
With the limited number of election cycles over the past 60-plus years, it’s challenging to draw dependable determinations about the presidential election cycle theory. However, you can also see results over these last 60-plus years that every third year in a presidency, the stock market saw a gain of over 16%.
Overall, the results from the presidential election cycle theory have not been too steady. Unfortunately, the direction of the stock prices has not been consistent from one cycle to the next.
The bullish trend in year three has proven more stable, with average gains far outdoing those of other years. Not to mention, roughly 90% of those presidential cycles since 1950 experienced a market gain in the year after the midterm election.
Since presidential elections only happen once every four years in the United States, there’s just not a large enough data sample from which to draw conclusions on whether the presidential election cycle theory is reliable or not. The reality is that there have only been 17 elections since 1950.
And even if the election cycle and market performance corresponded, it doesn’t mean there is causation for the two. It may just be that the markets tend to surge in a presidency’s third year.
With President-elect Biden taking office following a tumultuous year, investors of every stripe will be waiting to see what happens over the next four years.
- Cook, Jennifer. “Presidential Election Cycle Theory Definition.” Investopedia, Investopedia, 19 Nov. 2020, www.investopedia.com/terms/p/presidentialelectioncycle.asp.