The Election Cycle

Shares, Strategies & Common Sense

A prosperous economy and a booming stock market virtually guarantee re-election of an incumbent administration.

Interest rates are the single most powerful factor affecting the stock market. As sure as the moon causes ocean tides to rise and fall, interest rates cause share prices to do the same. Share prices go up when interest rates go down, and fall when interest rates go up.

There is another powerful force, however, that comes along every four years that overrules interest rates. It's The Presidential Cycle. It doesn't matter whether interest rates are rising or falling, the stock market goes up during the last two years of a presidential administration.

This phenomenon is neither coincidental nor accidental. It is the result of political forces striving to boost the economy. A prosperous economy and a booming stock market virtually guarantee reelection of an incumbent administration. According to Yale Hirsch, Editor of the 1997 Stock Trader's Almanac, "the last two years of the 41 administrations since 1832 produced a total net market gain of 592% compared with 79% gain of the first two years of these administrations. The average gains were 14.4% and 1.9% respectively.

Clearly, incumbent administrations not only strive to look good in the last two years in office, but they make the hard decisions, such as raising taxes, during the first two years.

The stock market rose 12% in 1992, the year Mr. Clinton was elected. It went up 7% in 1993, his first year in office, and fell 2 percent in 1994, his second year in office. The average gain for Mr. Clinton's first two years in office was 2.5%, not far from the historical average of 1.9%.

The stock market, as measured by the S&P 500 Index, was up a sensational 43.0% in the third year of Mr. Clinton's administration, and 22.9% in 1996. This performance was well above the historical average of 14.4% gain for the last two years in office. Does this mean the market will correct in 1997 and 1998? Not necessarily, but there is very little chance that 1997 and 1998 also will be outstanding years for the market. It appears that 1997 will be an up year for the stock market, but it will likely fall short of the boomers we experienced in 1995 and 1996.

This observation is based upon a number of factors. First of all, it's a simple statistical phenomenon that large gains are followed by smaller gains and viceversa. Since the 1995 and 1996 gains are large by most standards, the 1997-1998 gains are likely to be far less.

Another piece of evidence supporting this view is the observation made by Mr. Dick A. Stoken, in his book "Strategic Investment Timing." He states that, "The really juicy part of the election cycle is the fifteen-month period beginning in early October, two years before the election, and lasting until early January of the election year." In other words, the juicy part of this election cycle started early in October 1994 and ended early in January 1996.

Mr. Stoken justifies this claim by noting that from 1934 through 1982, the market gained an average of 25% during this fifteen month period compared to only 1% for the other 33 months of an administration's term in office. Since Mr. Stoken's book was published in 1984, I performed the same calculations for 1986, 1990, and 1994. The averages were as follows:

Election Year Prime 15 Months %Gain/(Loss) Other 33 Months Year %Gain/(Loss)
1982 38.00% 44.50%
1986 07.30% 26.20%
1990 24.50% 26.70%
1994 33.10% N/A

We see here that the presidential election cycles of 1982, 1986, and 1990 contradict Mr. Stoken's claim that the "Prime 15 months" outperform the "other 33 months." The last time this happened was in the period from 1942 through 1950. Subsequently, (from 1954 through 1978), the "Prime 15 Months" of The Presidential Cycle far outgained the "Other 33 Months." Is this about to happen again? History says it is.

While it's fun studying historical phenomenon such as The Presidential Cycle, one would be better served by staying with fundamentals. Share prices rise when inflation and interest rates go down and earnings go up. This is exactly what happened in 1995 and 1996, but the trends are likely to weaken in 1997 and 1998. Inflation will not go down much further, so interest rates will have a bias to rise. Earnings growth is still on the rise, but the rate of earnings growth is slowing.

This scenario says that the stock market will be OK in 1997 and questionable in 1998. Obviously, we have seen the best of The Presidential Cycle. According to Mr. Stoken, the next big up-move in the market will begin in October 1998. Mark this date on your calendar.