Presidential Election Cycle Theory

Deciphering the Presidential Election Cycle Theory: Fact or Fiction?

Unveiling the Presidential Election Cycle Theory

The world of stock trading is awash with theories and strategies, each promising a unique insight into the market's mysterious movements. One such theory that has garnered attention over the years is the Presidential Election Cycle Theory. This theory, crafted by the founder of Stock Trader's Almanac, Yale Hirsch, suggests that stock market returns follow a cyclical pattern based on the U.S. presidential election cycle.

According to Hirsch's theory, the stock market typically experiences a sluggish performance in the first year following a presidential election. As the president settles into office and focuses on implementing their policy agenda, the market tends to rebound, reaching its peak in the third year. However, as the president's term nears its end, market performance often dips in the fourth year, paving the way for a new cycle with the subsequent election.

The Genesis of the Presidential Election Cycle Theory

Yale Hirsch's Stock Trader’s Almanac, first published in 1967, quickly became a revered resource among day traders and fund managers alike. Beyond offering market insights for specific times of the year, such as the "Santa Claus Rally" and the "Best Six Months" hypothesis, Hirsch also introduced the concept of the presidential election cycle as a crucial determinant of stock market performance.

Hirsch's theory hinges on the idea that a new president's initial years are often dominated by the pursuit of policy goals and appeasing key supporters. However, as the next election looms, presidents typically shift their focus to bolstering the economy, hoping to secure re-election. This shift in priorities, according to the theory, tends to coincide with improved stock market performance, irrespective of the president's political affiliation.

Putting Theory to the Test: Empirical Evidence

While the Presidential Election Cycle Theory offers an intriguing perspective, does it stand up to empirical scrutiny? A study by Charles Schwab in 2016 delved into market data dating back to 1950, revealing some compelling insights.

Year after the election: 6.5% average return
Second-year: 7.0% average return
Third-year: 16.4% average return
Fourth-year: 6.6% average return

These findings not only corroborate Hirsch's theory but also highlight the third year of a presidential term as a period of particularly robust market gains. Moreover, data from 1950 to 2019 shows that the market witnessed gains in 73% of all calendar years, but an impressive 88% during the third year of a presidential term.

Exceptions and Limitations

While the Presidential Election Cycle Theory offers valuable insights, it is not without its limitations and exceptions. For instance, Donald Trump's presidency deviated from the predicted first-year stock slump, with significant market gains driven by tax reforms in his first year.

Moreover, the theory's predictive power is somewhat constrained by the infrequency of presidential elections, with only 17 elections occurring since 1950. This limited data set raises questions about the theory's reliability across different election cycles.

Furthermore, correlation does not imply causation. While stock market gains often coincide with the third year of a presidential term, attributing this solely to presidential actions oversimplifies the myriad factors influencing market dynamics. Global events, political landscapes, and natural disasters can all exert significant influence on stock market performance.

Insights from the Theory's Custodian