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This Election Year Could Have A “YUGE” Effect On Markets

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This Election Year Could Have A “YUGE” Effect On Markets by Frank Holmes

Ready or not, here they come. Only four months remain before we find out who the next presidential nominees will be and a mere eight months before we elect one of them to lead the world’s largest economy. That means there’s no better time than now to start thinking about how this whole process could affect your investments—and how to prepare.

The theory of the presidential election cycle was devised in the late 1960s by investment advisor Yale Hirsch and first described in the indispensable Stock Trader’s  Almanac, now edited by his son Jeffrey Hirsch. Although some of the specifics of Yale’s theory have been called into question over the years, its essence remains rock solid—namely, there’s a strong correlation between the election cycle and market performance. Like all major cycles, from seasonality trends to the weather, the election cycle helps us manage our expectations by giving us an idea of how markets might behave in certain circumstances. The past can’t guarantee what will happen in the future, but it’s a good place to start.

2016: An Atypical Election Year

According to market data going back to 1928, stocks have annually gained an average 7.5 percent, and in election years, they’ve done slightly worse, at 7 percent.

But 2016 isn’t a typical election year, and not just because our nominees could be Donald Trump, a billionaire real estate mogul and reality-TV celebrity, and Bernie Sanders, a self-described democratic socialist. If we look just at the eighth and final years of two-term presidencies going back to 1928, stocks have lost an average 4 percent.

There could be a few reasons why this has been the case, one being that presidents in their eighth year aren’t eligible for reelection, making their actions a little less predictable than usual. As we all know, President Barack Obama will soon complete his second and final term, and there’s uncertainty as to who will succeed him (whether or not you’re happy to see him leave). With new leadership comes new government policies, and it’s this uncertainty that might contribute to investor jitters.

You might think that this is bad news for the market—especially after a weak 2015—but it’s worth pointing out that the data is pretty scarce. Since 1928, there have been only four presidential elections in which the incumbent was ineligible to run again: 1960, 1988, 2000 and 2008. (We’re not counting Presidents Coolidge and Johnson, who chose not to seek second full terms.) Therefore, an unusually large move in either direction will have a significant impact on the average—think 2008, when the S&P 500 Index plummeted 36 percent.

Anticipate Before You Participate

Of course, 2016 could still very well present many attractive buying opportunities. Since 1932, May has been a good entry point ahead of a summer rally during election years. (The chart below shows the monthly averages for all election years, not just those when a new president must be chosen.)

Election Year

As I often say, it’s not the party that matters so much as the policies. In Republican and Democratic administrations alike, the market has both climbed and tanked, often for reasons largely outside the president’s control. The global economy is monumentally important, as is the composition of Congress, which, after all, writes our laws and holds the nation’s purse strings.

Election Year

The point is, reading the market tea leaves isn’t nearly as simple as looking at which party’s candidate is occupying the Oval Office.

No doubt you feel as if November can’t come soon enough, but until then, it’s essential to follow the same basic fundamentals of investing and not get too caught up in the theater of this unique election season.

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Frank Holmes

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