Blog - Investing Notes

January 4, 2008 - Update: The Stock Market and the National Election Cycle

Many stock market experts cite the year (1, 2, 3 or 4) of the U.S. presidential term cycle as a useful indicator of U.S. stock market returns. Game theory suggests that presidents deliver bad news immediately after being elected and do everything in their power to create good news just before ensuing biennial elections. Are some presidential term cycle years reliably good or bad? If so, are these abnormal returns concentrated in certain quarters? Finally, what does the stock market do in the period immediately before and after a national election? Using S&P 500 index data from 1950 through 2007 (58 years) and focusing on "political quarters" (Feb-Apr, May-Jul, Aug-Oct and Nov-Jan), we find that:

The following chart presents the raw annual (January through December) returns for the S&P 500 index by year for 1950-2007, with shape/color coding to designate the four years of the presidential term cycle. There are 14-15 observations for each cycle year. Visual inspection suggests that years 3 and 4 may be better than years 1 and 2, and that years 1 and 2 are more variable than years 3 and 4. The two best and two worst years all come from year 2. Year 3 has no negative returns, and only two year 4 observations are negative.

To generalize, we compute average returns and standard deviations of returns by year and overall.

The next chart shows the average annual (January through December) return for the S&P 500 index for 1950-2007 for each year of the presidential term cycle and for all 58 years in the sample. The small squares mark the averages, and the variability ranges span one standard deviation above and below average. The statistics confirm that years 3 and 4 beat years 1 and 2, providing higher average returns at lower risk. Year 3 is especially attractive. However, the subsample size of 14-15 for each cycle year is very small, as is therefore our confidence in the results. In other words, a few very contrary future observations could change the statistics substantially.

Are there any interesting quarterly patterns within the annual statistics?

The next chart decomposes S&P 500 index returns by "political quarter" for 1950-2007. Political quarters accommodate the typical election breakpoint of early November, with political quarters therefore offset from calendar quarters by one month. The chart shows that the best political quarter overall is Nov-Jan (consistent with much other calendar effects research), with an average return of 4.8% across all 58 years and no negative observations. The worst political quarter is Aug-Oct, with an average return of just 0.3% across all 58 years. The strongest returns across the presidential term cycle come from Nov-Jan in year 2 through Feb-Apr in year 3; in fact, these are the only two quarters for which the average return is larger than the standard deviation of returns. Note that year 2 is a congressional election year, so November of year 2 brings some level of affirmation or repudiation to the President's party. Standard deviations for these political cycle quarters range from 4.4% to 9.1%, with May-Jul and Aug-Oct somewhat more volatile than Feb-Apr and Nov-Jan. Again, subsamples by political cycle quarter are very small, so confidence in these results is very low.

How do stock returns behave immediately around elections?

The next chart is a close-up of average daily S&P 500 index returns from 21 trading days before through 21 trading days after U.S. national elections for the total sample across 1950-2006 and several subsamples. Results for the total sample (light green line) include variability ranges spanning one standard deviation above and below average. The most consistent feature is a tendency to rally from about one week before election through one day after election, perhaps expressing investor relief that the campaign is winding down and/or reduced uncertainty in which party will prevail. As usual for daily return analysis, variability tends to swamp anomaly.

The average daily return for all days in this interval is 0.10%, nearly three times the average return for all days since the beginning of 1950.

What is the cumulative effect of these daily returns?

The final chart is a close-up of average cumulative S&P 500 index returns from 21 trading days before through 21 trading days after U.S. national elections for the total sample across 1950-2006 and several subsamples. The roughly 2% rally from one week before election through one day after election is consistent. The average return for all two-month periods during 1950-2007 is about 1.5%.

In summary, there appear to be both long-term and short-term connections between the U.S. national election cycle and stock market performance, with presidential term year 3 (1) the best (worst) and a tendency for a brief election-time rally. However, the subsamples for presidential term year analysis are very small, so confidence in related tendencies is very low.

For related research, see Blog Synthesis: Politics and the Stock Market, Blog Synthesis: Calendar Effects and the Trading Calendar.