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Posted on 24 August 2012 | 8,339 views

Stock Market Crashes on Presidential Election Years

If the stock market continues its surprising rally, Mitt Romney may be nothing more than a rich investor after the November elections, while President Obama gets started on a second term.

That’s the implication of an updated study on the effect of the stock market on presidential elections, which found a strong correlation between positive stock-market returns and the re-election of the incumbent when a sitting president is running for a second term. “Large stock market advances during the final three years of incumbent candidates’ terms tend to be strongly associated with subsequent landslide victories,” says the report from the Socionomics Institute, a research firm in Gainesville, Ga.

It’s hardly a revelation to suggest that a rising stock market boosts the re-election odds of an incumbent president. But the Socionomics research goes a step further by comparing the stock market to other factors such as unemployment, economic growth, and inflation–which, it found, have surprisingly little influence on presidential re-election bids. “The importance of these other variables remains relatively weak or insignificant when examined in combination with the stock market,” according to the study.

The Socionomics Institute is run by Robert Prechter, a controversial forecaster and social theorist who has been predicting a stock-market crash for several years. Prechter is also the lead author of the paper, which examined the stock market’s effect on U.S. presidential elections all the way back to 1824, when the necessary data was first available.

As all of the rhetoric heats up and the two largest political parties begin to duke it out heading for the November election, let’s take a look at the historical stock market reactions to the unavoidable presidential election cycle. Since the 1970’s, when we spiraled upward on the inflation scale to surpass 15% annual inflation rates and interest rates of 18, 19, 20% on 90 day treasury bills and short term certificates of deposit, the economy has been the leading driver in terms of election results. Over the last 40 years, some significant patterns have emerged

Most notable of these patterns is that the first two years of a new president’s administration usually result in lower or underperforming stock market results. The third year and into the final year of the first term generally are very good periods for stock market performance. In fact, in the years from 1946 through 2009, 62 percent of the American economy’s growth came during the final two years of presidential terms, compared with 38 percent in the first two years. A third of the growth came in the fourth years.

With a third of the growth coming in the fourth year of a presidential term, the chart below depicts investment returns (based on the S&P 500) for the election years since 1928. In my opinion, the best that can be said is that the results are interesting. While returns have been generally favorable, in recent years there have been some uncharacteristically bad results. In 2000 and in 2008, the declines would have eaten up all the gains since 1980. As stated already, it is however very interesting.

Stock Market Returns During Election Years (based on S&P 500)

Year Return Candidates
1928 43.6% Hoover vs. Smith
1932 8.2% Roosevelt vs. Hoover
1936 33.9% Roosevelt vs. Landon
1940 -9.8% Roosevelt vs. Willkie
1944 19.7% Roosevelt vs. Dewey
1948 5.5% Truman vs. Dewey
1952 18.3% Eisenhower vs. Stevenson
1956 6.5% Eisenhower vs. Stevenson
1960 0.50% Kennedy vs. Nixon
1964 16.5% Johnson vs. Goldwater
1968 11.1% Nixon vs. Humphrey
1972 19.0% Nixon vs. McGovern
1976 23.8% Carter vs. Ford
1980 32.4% Reagan vs. Carter
1984 6.3% Reagan vs. Mondale
1988 16.8% Bush vs. Dukakis
1992 7.7% Clinton vs. Bush
1996 23.1% Clinton vs. Dole
2000 -9.1% Bush vs. Gore
2004 10.9% Bush vs. Kerry
2008 -37.0% Obama vs. McCain
2012 Obama vs. ?

One strategy stands out as having been overwhelmingly successful has been to hold stocks only in the last half of the third year into the first half of the fourth year of any presidential term. I cannot confirm that anyone has used this strategy, however on paper it has yielded tremendous returns, and insured that investors were “out of the market” during the majority of losing years. The problem is that very few have the discipline or the wherewithal to pursue such a strategy. Brokerage firms certainly would not condone this approach as they would be without commissions for 3 years out of 4!

The point of looking at this approach and the phenomenon of stock market returns compared to presidential elections is to highlight the behavioral science aspect of investing. The concepts of herd mentality or blind leading the blind may be too harsh, but not at all unrealistic in describing what happens during these times. There is also the very real aspect of an incumbent president seeking reelection choosing to use any economic stimulant at his disposal in order to conjure up the appearance of a well functioning economy to help insure such reelection. This is made most evident when we see the dismal economic performance that has so frequently gone hand in hand with the first two years of each presidential term. Once elected, get back to the platform and don’t worry so much about economic growth.

There will always the search for the magic bullet that presents the best of all worlds to the investor. Nonetheless, a long term strategy based upon the main fundamentals of earnings growth, new products and services, and continuously building the customer base will always win out in the long run. It may be a good strategy to look beyond the recent run up in stock market prices, and seek only those shares with the proven ingredients for a sustainable upward price movement.

It’s also possible that this year’s election could simply diverge from the historical trend. It has happened before. The stock market rose by about 24 percent during the last three years of George H.W. Bush’s presidency, yet he lost his 1992 re-election bid to Bill Clinton. The main reason: a recession followed by a weak, “Jobless Recovery“, just as we have now. Maybe a new historical trend is forming.

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  • Jessica Johnson said:

    Stock Market Crashes on Presidential Election Years http://t.co/Xx8f7uoi

  • Joe said:

    The drop should have possible been higher considering the fact that the stock market had been closed for two days prior the election due to super storm Sandy. After a day of closing, the stock market historically has a good few days when returning.

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