Election Bull Market

Why do stocks rise during presidential election years?

If you ask people in the securities business, it’s always the right time to buy stocks. When stocks plummet for five straight sessions, they’re bargains. And when stocks have been rising parabolically for a period of several months, momentum is on your side.

Wall Street offers other theories to goose investors to buy. For football fans, for example, there’s the Super Bowl thesis, which essentially holds that when a National Football Conference team wins the Super Bowl, stocks do well the rest of the year. (When the AFC’s New England Patriots won Super Bowl XXXVII in February, mentions of this theory declined rapidly.)

There’s also an investment theory for political junkies. This is a presidential election year, and history shows that stocks do well in presidential election years. In a recent research report, Salomon Smith Barney equity strategist Tobias Levkovich noted the S&P 500 has returned a healthy average of 9.5 percent in presidential election years since 1900. In the 26 election years, the index has risen 20 times and fallen only six. Between 1964 and 1996, the S&P 500 rose in every presidential election year.

What explains the better-than-average historical performance? After all, stocks have done well in election years when the economy boomed and when it busted, in years when incumbent presidents won re-election and in years in which the White House changed hands.

It could be that in election years, incumbents—no matter who is in the White House, and no matter who controls Congress—take actions to bolster their re-election prospects. Frequently that means boosting the economy, through tax cuts or higher spending. And that’s usually good news for stocks. What’s more, the Federal Reserve Board, which hesitates to inject itself into politics, tends to avoid raising interest rates during election years. That’s usually good news for stocks, too.

But if you’re really intent on timing political cycles, don’t wait until the Iowa caucuses to buy. For while election years have been pretty good, pre-election years have been great. Jeffrey Hirsch and his colleagues at the Stock Trader’s Almanac have crunched the numbers, and the results are illuminating. Since 1901, the Dow Jones industrial average has gained 9.3 percent, on average, in presidential election years, with 17 up years and eight down years. But since 1901 the third year of presidential terms has seen average gains of 12.5 percent—21 up years and five down years. In the past four presidential cycles, the average gain in the Dow for the third year has been a whopping 24.3 percent.

If you believe that broad market performance is related to incumbents’ self-preservation instincts, this data suggests that economic re-election campaigns—like political re-election campaigns—are starting earlier and earlier. In other words, Washington may be jamming stimulus and tax cuts into the third years of presidential cycles so that the economy has more time to respond. What’s more, by acting early, Congress and presidents can avoid the paralysis that tends to set in during election years, especially when control of Congress and the White House is divided between the two parties—as it was for 18 of the 20 years between 1981 and 2001.

In this cycle, the pre-election year brought a veritable orgy of stimulus from Republican-controlled Congress, the Republican-controlled White House, and from the putatively nonpartisan Federal Reserve, which has all but become an adjunct to the Republican National Committee. Congress and the White House joined to cut taxes and pass expensive programs that they thought would be popular among voters—i.e., the Medicare prescription drug benefit. The Fed, perhaps knowing its actions would be scrutinized more sharply in an election year, reduced interest rates to historic lows during the third year. That was all really good news for stocks in 2003.

But 2004 is threatening to be an off-year in the presidential-election market theory. So far this year, the markets are treading water. Tobias Levkovich of Salomon Smith Barney predicts the S&P 500 will fall in 2004.

Greenspan has signaled that interest rates will probably be rising in 2004. President Bush and the Republican Congress, by cutting taxes while increasing spending rapidly, have created gigantic deficits that are now threatening to become a liability. In sharp contrast to last year, Republicans in Congress are now balking at expanding President Bush’s tax cuts, and the president has signaled his displeasure with runaway spending. With the economic boost of 2003, Washington may have used up all its ammunition. President Bush’s pre-emptive strike got one good year out of the market, but it might not get him two.

Thanks to Jeffrey Hirsch of the Stock Trader’s Almanac for providing the market/election data.