Does The US Election Cycle Affect The Stock Market?

Summary

• The stock market was reviewed from 1953 to present, covering 17 presidential election cycles, to explore a possible relationship between these cycles and resulting stock market levels (See chart in Verification section).
• Surprisingly, there is some data to back up the claim that there is frequently a large decline about 1.5 years after taking office, and a corresponding up-market shortly after, from approximately OCT-YR-2 to APR-YR-3.
• The hypothesis is only accurate about 75% of the time, and it is more compelling when it focuses on down-markets instead of rising-markets (the latter may be explainable by long-term stock-market-growth and doesn’t have the risks and opportunities of bear markets). (See my version of the hypothesis at the end of the Discussion section.)

Credit: DALL-E

Introduction and Hypotheses

There are a number of theories (hypotheses really) about how the US election process might affect the stock market.

According to this theory, U.S. stock markets perform weakest in the first year, then recover, peaking in the third year, before falling in the fourth and final year of the presidential term, after which point the cycle begins again with the next presidential election. — Investopedia referencing Yale Hirsch

There is also a more specific version of this theory listed on GMO:

Between October 1 of year 2, and April 30 of year 3, the stock market will have increased returns.

Graziadio Business Review has a related theory:

All of the major stock market declines occurred during the first or second years of the four-year U.S. presidential cycle. No major declines occurred during the third or fourth years.

Verification and Skepticism

As usual, I brought this back to first principles and looked at the data, using a high-level overview chart stretching back to 1953. Honestly, my gut told me that the presidential cycle theory was far too simplistic, and probably a conspiracy theory touted by “gold-lovers”.

To my surprise, there is at least some backing for the hypothesis:

• Out of 17 full presidential cycles analyzed, 15 of them were headed upward during the Oct-Apr timeframe. (Note: The stock market as a whole is always increasing over time, so one would expect this to be occurring a large percentage of the time over a random sampling.)
• Looking at the chart, it becomes rapidly apparent that the majority (12 of 16) of the large downturns (-15%+) hit bottom just before the target Oct start date (basically 1.5 yr after taking office.)
• Also, of the 18 times in the chart where it was “1.5 yr after taking office”, 13 of those had a large downturn then.
• There were four additional large downturns that didn’t fit the timing pattern, and at least 4 cases where one would have expected more of a downturn to occur given the timing. So, results are mixed.
• I am no statistician, but this seems to be accurate more often than one would expect by chance alone, and this is backed up by the following analysis by GMO. (It should also be mentioned that the sample size of both their analysis and mine are fairly small, which may make statistical analysis impossible.)

Credit: GMO

• Regarding the Graziadio assertion, it is untrue: there were major stock market declines (bear markets) in the third or fourth years in 1987, 2008, and 2020. Admittedly, this is a fairly lower percentage however.

Discussion

• Clearly there are more variables at play that just the 4-year election cycle. Even if the hypothesis is partially true, it can be derailed by other significant factors — but it is debatable whether this is relevant for investors. I would argue that you always want to know the real root cause.
• I am more interested in predictions of down-markets than up-markets. The SP-500 is always headed up in the long term (here’s why), so simply predicting that market should be going up at a random time would be right, more often than not. Predicting when it is “not going up” is MUCH harder.
• In many cases, the market is not back to RH when the 2-yr-OCT mark hits, and that seems to be a factor of how deep the preceding bear market was (it may not have had time to recover yet.)
• The business press often (nearly all the time) mistakes correlation for causation. It is entirely possible that other significant hidden factors happen in the third year of the presidency that result in the increase. Investopedia is surprisingly logical and scientific in their analysis:

Even if two variables are correlated — in this case, the election cycle and market performance — it does not mean that there’s causation. It could be that markets tend to surge in the third year of a presidency, but not because of any re-prioritizing by the White House team. — Investopedia

• Which party is in power and whether a power-split between the presidency and the congress matters is beyond the scope of this article, and is covered nicely here: Do U.S. Election Results Influence the Stock Market? — answer: probably not.
• If I were to make my own hypothesis to add to those presented in the introduction it would be something like this:

75% of the time, there will be a significant down market (typically in the 10% — 30% range) in the 2nd year after a president takes office. — Jeff Axup

Note: The above could be empirically validated, making it a valid hypothesis.

Tips

• Be wary of the time period around 1.5 years after a president takes office. It is often paired with a steep decline.
• The peak of the 2022 bear market happened at the 1.5 yr mark and shortly after. At the time of this writing (FEB 8, 2023), we are in the “rebound” period which typically follows it.
• This rule doesn’t work 100% of the time. It is likely that other factors can erase an impending downturn before it begins.

Community Questions

• Do you think the President has the power to improve market performance before an election?
• What other factors might be the actual root cause for an increase in market investment in year-3 of the election cycle? Is it possible the president does nothing and the people just feel more safe and greedy during this time period?
• If we were to make a prediction for 2023 based on the above investment hypothesis, it would be: “If the 1.5 yr drop has already occurred (it has), then there should be a significant rise in stock value (perhaps back to RH).” I am not necessarily making this prediction, but I am watching to see if it happens. What do you think?

Notes

• I do not hold any financial degrees or certifications. I am not a tax advisor. Your investment decisions are your own, and it is best to test strategies with small amounts of money first, preferably after extensive back-testing.