This Strategy Has Paid Off for 80 Years

06/20/2011 3:00 pm EST

Focus: MARKETS

Mark Hulbert

Senior Columnist, MarketWatch

Stock indexes have risen in the third year of a presidential election cycle since the days of Herbert Hoover. What this means, says Mark Hulbert in this exclusive interview with MoneyShow.com, is not to throw caution to the wind, but maybe accept a little more risk in your portfolio, at least for the next few months.

We’re in the third year of a presidential election cycle. What does that mean for investors?

Well, the whole presidential election year cycle has been getting a lot of press lately, and it turns out for good reason.

If you go back for the last 70 or 80 years, the market has had very distinct patterns according to where we are in the presidential term. It turns out that the third year of a president’s term is the one most positive for the stock market, at least historically.

In fact, going back to 1932, there has been no third year of a president’s term in which the stock market declined—it didn’t always go up huge amounts, but I think the worst year was still a gain of 2%, and then of course some years have been fantastic. Turns out that so far, the third year has lived up to that pattern, and we’re only about, a little over halfway through the third year, so it’s interesting.

I went and looked at the investment newsletters that I track; I track nearly 200 of them, and I wanted to look to see whether the newsletters that did well in third years tend to be different than the newsletters that do well overall, and it turns out that there’s quite a big difference.

I looked down into the data a little bit more, and it looks like the newsletters that do the best in the third year are the ones that tend to be the riskiest. So, you’ll have newsletters that have incredibly risky strategies that probably don’t serve them well—if I could be so bold as to say that to them.

But nonetheless, that risk works in their favor when the market is going up, which it tends to do in the third year, so the real question for investors is whether you think the market has already discounted the rest of the third year because we’ve already had...in fact, if the market were to stop right now, it would already go down in history as one of the better third years that we’ve had, but it might continue a while longer.

If so, you might want to go a little bit further out on the risk spectrum, favoring advisors or strategies you might not otherwise favor in other parts of the cycle.

What is your view on that?

Well, I worry, and I worry for the following reason: So many people are talking about it. There are a lot of people who previously didn’t know about it who now say, well of course, I know all about it.

Of course, the markets are a great discounting mechanism. Once they know about something, they tend to shift the gains that otherwise would occur in the future into the present.

So if you know that the market’s going to go up through the end of the third quarter and the end of the fourth quarter, you’re not going to wait until then to invest; you’re going to invest in it now, and thereby transfer some of those gains into the current period.

We’ve had such a strong run in the market. It may be that some of that strength has discounted some of that future gain.

I should note, in this regard, that one of Wall Street’s biggest proponents of the presidential cycle and investing in year No. 3 is a hedge-fund manager by the name of Jeremy Grantham. He’s the chief investment strategist at a Boston-based firm called JMO.

He originally said that despite the fact that he was bearish on the overall market, and thought that stocks were overvalued, that nevertheless the third year is an exception, so go ahead and invest in the market, and look to get out of the market by October 1.

The reason he was focusing on that is that he calculates and looks at the presidential election year cycle in fiscal-year terms, so it ends on September 30, rather than calendar-year terms. So he was saying you want to get your chips off the table by the end of September or early October.

He just came out in early May with his latest letter to clients, in which he decided that he was going to revise his previous recommendations to say start taking money off the table now.

But do you think that it’s really a sustainable trend? I mean it has been, obviously for a very long time, but there are always some other complicating factors, I would think.

Well, absolutely. No one wants to track any one particular indicator at the expense of all others, but what it does suggest, again, is an overlay to look at in the context of whatever other strategy you’re following. And it suggests that maybe you should be erring on the side of a little bit greater risk tolerance in the third year.

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