Election-Year Forecast

Voters won’t be the only ones paying attention to the presidential election – the stock   

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Voters won’t be the only ones paying attention to the presidential election – the stock market will also feel the influence as we count down to Election Day in November.

Election-Year Forcast (from Lancaster County Magazine, May 2012)Investors have used everything from the winner of the Super Bowl to hemlines to predict the direction of the stock market. Election cycles may be just another indicator that doesn’t really have anything to do with stock prices. But then again, maybe they do. The executive branch wields a lot of influence over fiscal policy, which affects taxation and spending patterns in ways it aims to improve the economy. No politician can ignore the relationship between the health of the economy and votes. The theory is that the incumbent will try to influence the economy to expand during an election year in the hope that voters will reward him or her at the ballot box. That theory hasn’t always worked out, as the table to the right suggests.

Initially, it would appear that most presidential-election years have been good for the stock market. Unfortunately, that theory didn’t work so well during two of the last three elections. A report published by two Federal Reserve economists in 2004 concluded that neither risk nor return in the stock market is significantly different across the presidential cycle.

It’s not that the president doesn’t want to use fiscal policy to improve the economy and win reelection. In fact, one could argue that presidents should be helping the economy the whole time they are in office. Economists remind us that influencing the economy is not easy and the effects of policies often take time to work. Other factors may have a greater influence on stock prices, like the bursting of the technology bubble during the 2000 election year.

Perhaps the greatest problem an election year creates is uncertainty. Investors don’t like uncertainty, even though they have to deal with it all the time. The potential change in the Oval Office raises uncertainty over the new president’s policies and how much success he or she may have in implementing policies. Often, those policies have their potential winners and losers that keep investors on the sidelines. For example, President Obama campaigned heavily on promoting alternative energy and companies involved in those fields benefited during his first years in office.

The investment research firm Leuthold Group notes that it’s the 200 trading days after the election that you want to watch. Its research shows that stocks have increased on average by 18.3% after every midterm election since 1942. The group’s conclusion is that investors hate uncertainty and just getting past the election is a reason to rally.

The Presidential Election Cycle Theory is fun to debate, but it shouldn’t be taken seriously by investors. This theory worked reasonably well for many years – except when it didn’t. No one can predict the short-term moves of the stock market. The president may indeed want to influence the economy in a positive way that would benefit the stock market. However, as George W. Bush was reminded in 2008, the economy doesn’t always cooperate the way you want.

These concerns may be largely unfounded, as research by Vanguard would suggest. In a study published in October 2008, Vanguard found that the stock-market return since 1852 has been virtually the same for Republicans (8.66%) and for Democrats (8.97%). This would support the contention that there will be companies that benefit and those that suffer under a president’s policies – no matter which party is in office. The stock market will eventually figure it out and reward those companies that benefit. Whether the Democrat continues to hold onto the White House or the Republican challenger wins, the next four years probably won’t matter to the stock market.

Your investment strategy in 2012 should be built around your long-term financial goals, not the presidential election. Where do you want to be in five, 10 or 25 years? How much of your financial assets need to be allocated to stocks to get you there? Now, stick to your strategy. If the stock market drops, you will be under-weighted and need to buy more stocks when you rebalance. This forces you to buy low. If the stock market rallies, you will end the year over-weighted and it will be time to take some profits to rebalance

Successful investors monitor their investment strategy and periodically rebalance to take advantage of the stock market’s volatility. Too many investors try to avoid volatility by attempting to determine when to sell stocks to avoid the downturns. No one can do that consistently. The great investor Peter Lynch said, “I can’t recall ever once having seen the name of a market timer on Forbes’ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.”

Then again, we could be looking at the presidential election from the wrong standpoint. The outcome of the election may not impact the stock market as much as the stock market influences the outcome of the election. No incumbent party has won an election in a year the stock market finished lower in the last 100 years. If this holds true in 2012, President Obama will be cheering for an up market … and hemlines on dresses to be higher!

S&P 500 Stock Market Returns During Election Years (from Lancaster County Magazine, May 2012)

This article originally appeared in the May 2012 issue of Lancaster County magazine

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