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20/07/2010 Stock Market and the National Electio…

Objective research and reviews to aid investing decisions

Stock Market and the National Election Cycle


Posted in Calendar Effects, Political Indicators

June 30, 2010

Many stock market experts cite the year (1, 2, 3 or 4) of the U.S. presidential term cycle as a useful indicator
of U.S. stock market returns. Game theory suggests that presidents deliver bad news immediately after being
elected and do everything in their power to create good news just before ensuing biennial elections. Are some
presidential term cycle years reliably good or bad? If so, are these abnormal returns concentrated in certain
quarters? Finally, what does the stock market do in the period immediately before and after a national
election? Using S&P 500 index data from January 1950 through April 2010 (over 60 years) and focusing on
“political quarters” (Feb-Apr, May-Jul, Aug-Oct and Nov-Jan), we find that:

The following chart presents the raw annual (January through December) returns for the S&P 500 index by
year for 1950-2009, with shape/color coding to designate the four years of the presidential term cycle. There
are 15-16 observations for each cycle year. Visual inspection suggests that years 3 and 4 may be better than
years 1 and 2, and that years 1 and 2 are more variable than years 3 and 4. The two best and two of the
three worst years all come from year 2. Year 3 has no negative returns, and only three year 4 observations
are negative.

To generalize, we compute average returns and standard deviations of returns by year and overall.

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The next chart shows the average annual (January through December) return for the S&P 500 index for
1950-2009 for each year of the presidential term cycle and for all 60 full years in the sample. The small
squares mark the averages, and the variability ranges span one standard deviation above and below average.
The statistics confirm that years 3 is especially attractive. However, after 2008, year 4 no longer clearly beats
years 1 and 2, though it is somewhat less volatile. The subsample size of 15 for each cycle year is very small,
as is therefore confidence in the results. In other words, a few very contrary future observations could change
the statistics substantially.

Are there any interesting quarterly patterns within the annual statistics?

The next chart decomposes S&P 500 index returns by “political quarter” for January 1950 through April
2010. Political quarters derive from the typical election breakpoint of early November, with political quarters
therefore offset from calendar quarters by one month. The chart shows that the best political quarter overall is
Nov-Jan (consistent with much other calendar effects research), with an average return of 4.2% across all 60
years. The worst political quarter is Aug-Oct, with an average return of -0.1% across all 60 years.

The strongest returns across the presidential term cycle come from Nov-Jan in year 2 through Feb-Apr in
year 3; in fact, these are the only two quarters for which the average return is larger than the standard
deviation of returns. Note that year 2 is a congressional election year, so November of year 2 brings some
level of affirmation or repudiation to the President’s party. Standard deviations for these political cycle
quarters range from 3.6% to 9.1%, with Aug-Oct most volatile and Feb-Apr least volatile. Again,
subsamples by political quarter are very small, so confidence in these results is very low.

How do stock returns behave immediately around elections?

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The next chart is a close-up of average daily S&P 500 index returns from 21 trading days before through 21
trading days after U.S. national elections for the total sample across 1950-2008 and several subsamples.
Results for the total sample (light green line) include variability ranges spanning one standard deviation above
and below average. The most consistent feature is a tendency to rally from about one week before election
through one day after election, perhaps expressing investor relief that the campaign is winding down and/or
reduced uncertainty in which party will prevail. As usual for daily return analysis, variability tends to swamp
anomaly.

The average daily return for all days in this interval is 0.10%, about three times the average return for all days
since the beginning of 1950.

What is the cumulative effect of these daily returns?

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20/07/2010 Stock Market and the National Electio…
The final chart is a close-up of average cumulative S&P 500 index returns from 21 trading days before
through 21 trading days after U.S. national elections for the total sample across 1950-2008 and several
subsamples. The roughly 2% rally from one week before election through one day after election is consistent.
The average return for all two-month periods during 1950-2008 is about 1.3%.

In summary, there appear to be both long-term and short-term connections between the U.S. national
election cycle and stock market performance, with presidential term year 3 (1) the best (worst) and a
tendency for a brief election-time rally.

However, the subsamples for presidential term year analysis are very small, so confidence in related
tendencies is very low.

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