Hulbert on Why You Shouldn’t Fear the Presidential Cycle

Conventional wisdom holds that the second year of a U.S. president’s term in office — which, for President Obama, began this week — tends to be a bad one for stocks. But in his latest MarketWatch column, Mark Hulbert says that’s a misconception, and that the “presidential cycle” likely won’t have much effect on the market this year anyway.

Hulbert looks at the Dow Jones Industrial Average’s returns by presidential year over two periods: 1896 (when the Dow was created) to the present, and 1940 (when many say Franklin D. Roosevelt began the practice of presidents having a major impact on the economy) to the present.

The data shows that the second year in a president’s term on average has been met with a 4.7% Dow gain since 1896 — the worst year of the four-year cycle. But since 1940, the second year has actually been the second-best performer, generating returns of 5.6% per year.

The bottom line : “The picture painted by the data is less of abnormal weakness during the first and second years of the cycle than it is of abnormal strength in the third year,” writes Hulbert, noting that since 1896 the Dow has returned 12.5% in the third year of presidents’ terms; since 1940 the figure is 16.5%.

“What this means: One can’t, at the 95% confidence level, conclude that the stock market in the second years of a president’s term is likely to be a below-average performer,” he says.

Even if there were a discernable subpar trend for second years, Hulbert says you’d probably have to throw it out the window this year. That’s because of the huge government stimulus efforts already enacted. Hulbert notes that Jeremy Grantham “believes that the government’s stimulus program last year in effect turned 2009 into the functional equivalent of a third year of a president’s term. Per Grantham’s argument, the stock market’s prospects for 2010 therefore depend on how much longer and further the government can and will extend its stimulus. … The Presidential Election Year Cycle has little to say about what 2010 has in store for the stock market.”

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