Here we are in the middle of the third month of an election year, and the stock market is going gangbusters: The Standard & Poor's 500 index, for example, closed 2011 at 1257.60 and hit 1401.07 today, an 11.4 percent increase.
Is it a coincidence or the presidential election cycle at work? That's a theory that posits that the stock market does better in the second half of a president's term. In an interview two months ago, editor of the "Trader's Almanac," Jeffrey Hirsch, told me:
You hear that there have been no losses in the third year of a president's term since 1939, and it's because of the way that the incumbent party and the White House will do whatever they can to manipulate the economy so that voters are prosperous and happy when it comes time for the election the following year. So we see gains and prosperous times and peace during the second two years of a president's term and war recession and bear market in the first two years.
There is a compelling pattern, though correlation is not the same as causation.
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A post on Investopedia from September 24, 2011, "The market and presidential promises," illustrates the theory with a chart showing stock market returns by U.S. presidential term years.
There's an even more comprehensive chart on the website for the Graziadio School of Business and Management at Pepperdine University.
Between 1942 and 2004, "Three of the 16 bear market lows occurred in year one of the presidential term, 12 in year two, one in year three and none in year four, the election year," according to the story linked above, "Presidential elections and stock market cycles."
That's not all. The S&P 500 has historically done better in elections years in which the incumbent president wins the election, the winter 2012 issue of the T. Rowe Price Report tells us in the story, "The stock market in presidential election years."
The S&P 500 has risen in 12 of the 16 election years since World War II. While that’s about the same percentage of all up years in that time, the index had an average gain of 9.2 percent when the incumbent party won and just 2.2 percent when it lost, according to Ned Davis Research. The market has declined, however, in 2 of the past 3 presidential election years.
What does that mean for investors this year? If only I knew. There are a number of variables swirling in the ether: the perennial unrest in the Middle East becoming more perilous with tensions between Iran and Israel, the continuing situation in Europe, and the tenuous economic recovery in the United States -- to name a few.
In the end, the stock market is mostly made up of human investors whose behavior could be affected by any number of emotions including those brought on by politics. Bankrate's Financial Security Index for March will be released on Monday of next week, and the story examines the connection between political beliefs and attitudes toward the economy.
What do you think about the election cycle and the stock market?
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