Inside Scoop on the Presidential Cycle

11/28/2011 11:35 am EST

Focus: MARKETS

Mark Hulbert

Senior Columnist, MarketWatch

Mark Hulbert looks at the presidential cycle in the stock market and what it may mean for a year-end rally, as well as the prospects for stocks in 2012.

I want to take a moment and personally thank you for all these 30 years that you’ve been doing this wonderful work, rating the actual investment picks of all these investment advisory newsletter services that has been the basis for a lot of our decisions to invite many of our speakers back…and of course it’s been a basis for millions of investors over the years.

You’re welcome and thank you for bringing these people together in one place, which is a wonderful opportunity for investors to actually get to see side by side what strategies and what personalities they are likely to be comfortable with through thick and thin. It’s a huge service. Thanks.

That’s what I wanted to talk about, is the work that you do, which includes scanning several hundred advisory services, some of which you’ve been scanning going all the way back to the beginning, 30 years ago.

Also, what’s going on in the markets as we enter 2012. In particular, your thoughts on the presidential election-year cycle. The third year was supposed to be a pretty strong one, as I recall from that idealized cycle, and then the fourth year is supposed to be the best. Is that correct?

Well, it’s interesting. A lot of people tend to think that it is, but the data doesn’t show it. Everyone, if you were to ask without actually going through the data, most people would say the year before an election is going to be one where everything is roaring and the stock market should be going great guns, but it just doesn’t happen.

If you go back and look at the last 70 years or the last 100 years, it doesn’t matter how you slice and dice the data. What comes out is that the fourth year, if anything, is slightly below average relative to the whole period of time. The best year is the third year.

You were mentioning the third year, but it turns out, in fact, if you look at the way the idealized cycle works, really the only thing in a election year cycle that is worth writing home about is the third year. The third year does seem to have something unusual going in its favor.

This last third year was one of the more disappointing of the third years…but the average is over 20% for all third years going back to 1932.

That portends perhaps a very strong year-end rally?

Who knows? In fact, I’ve actually seen no relationship in the data between whether the third year turns out to be a good one or bad one and what we see in the year-end. I do see, though, that the fourth year is.

This isn’t to say that the fourth year or the next 12 months won’t be a good one. It could very well be a good one, but it won’t be because it’s the fourth year of the presidential term.

And you did some quarterly work on the presidential election-year cycle.

Well, that’s right. Again, one always has to worry when you slice and dice the data too finely and try to put too much meaning on each little blip in the data.

But yes, if you look at it on a quarterly basis—and by the way, when I look at the fourth year and any of the years of the cycle, I’m following the lead of a lot of researchers and looking at it on a fiscal-year basis, which means that it begins on October 1 and ends the following September 30…so it means that the fourth year began on October 1, so that’s the basis of this. So, quarter No. 1 of the fourth year would be the one that ends on December 31, 2011. Quarter No. 2 would begin on January 1, 2012.

What it shows is that on a quarterly basis, the fourth year ends up hitting a trough in that third quarter of the fourth year, which would be the quarter that begins on March 31 and lasts until June 30, and then tends to pick back up again near the end of that fourth year, which is the final period before the election.

I don’t think it has anything to do with the elections, per se. I think the stock market is just counting stuff well into the future, as it always does, and I think it’s seeing that anything that is artificially done to prop up the economy is something that you have to pay the piper eventually. So they are looking at the bad news that goes with the good, and aren’t getting too excited about whatever artificially is being done.

So, based on that, we’d have a pretty strong year at the beginning, then a plateau, and then some strength toward the end.

I’ll put it in relative terms. It’s a better period at the beginning and the end, but not so good in the middle—but even the average returns in those first two quarters of the fourth year are pretty modest, 1% or 1.5%. As an average, that’s not a lot to write home about. The other thing to remember is that the data are pretty variable.

Did you look at the actual returns if the incumbent party wins versus the incumbent party loses in the presidential election-year cycle?

I did, and it’s fascinating—there’s a huge dichotomy in the returns, depending on whether the incumbent party wins re-election. Though I’m not sure what we make of it, because what it means is that if the economy is doing very well, then the incumbent tends to win reelection, and of course the stock market will do better when the economy is doing well.

What does that mean for the next 12 months if we thought that President Obama was going to win reelection because the economy is doing well? Those are two big ifs, right? Then, you might say well, that means the stock market will do OK for this coming year. But those are two big imponderables.

Maybe all you really can get out of the data is that the stock market follows the lead of the economy, and you can’t in the presidential election-year cycle itself use that as any basis of a prediction of what’s going to happen over the next 12 months.

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