My Comments: Many of us are climbing a wall of worry about our investments over the next 12 months. I’m not worried if your time horizon is ten years or more, but if it’s less, then I believe you have reason to be worried.
Every week I’ve posted articles that justify the wall of worry. As soon as I’ve hit the “post” button, however, along comes something that seems legitimate to make me question my reasoning. Here’s another. And it’s not the only one.
Willow Street Investments, Nov. 18, 2014
• An average investor needs to know about the interrelationship between politics, economics, and the stock market to make more informed investment decisions.
• Incumbent presidents push for votes by proposing tax reductions, increasing spending on specific government programs and/or pushing for lower interest rates as an election draws near.
• The most favorable period for investing during a presidential cycle is from October 1 of the second year of a presidential term to December 31 of the fourth year.
• Barring a severe global and economic event, all major stock market declines have occurred during the first or second years of the four-year U.S. presidential cycle.
• Barring a severe global and economic event, no major declines occurred during the third or fourth years of a presidential cycle.
Investors in the stock market are always looking to past history to try and gain an edge for their investing strategy in the future. Frequently, gazing at stock market history in relation to political, economic and social events can provide investors with a window into the future of what may happen in the stock market. Other times, however, the weighted expectations of investors relying too much on history may alter what can be seen through the window to the future because an investors’ expectations of one scenario occurring may be altered by investors own behavior. Like the Farmer’s Almanac, that professes to be able to make long-term yearly weather forecasts for all across the U.S., stock market truisms such as “the January effect,” “Sell in May and Go Away,” and “the Santa Claus rally” are discussed one every year or so as predictive devices to aid in an investor’s investing strategy. Another stock market truism is looking at the 4-year U.S. presidential cycle and the behavior during such cycle.
Recently, we were reviewing an insightful article entitled The Four-Year U.S. Presidential Cycle and the Stock Market by Marshall Nickles and Nelson Granados. This article references a 2004 article, “Presidential Elections and Stock Market Cycles” written by Marshall Nickles. In Mr. Nickles’ earlier article, he noted that all of the major stock market declines occurred during the first or second years of the four-year U.S. presidential cycle. He also noted that no major declines occurred during the third or fourth years of a presidential cycle. In particular, from 1950 to 2004 (using the Standard and Poor’s 500 Index), the most favorable period (MFP) for investing was from October 1 of the second year of a presidential term to December 31 of the fourth year. The remaining period, from January 1 of the first year of the presidential term to September 30 of the second year, was the least favorable period (LFP) for stock market investors. The author concluded in their first article that “it appeared that politicians were anxious to exercise policies that were designed to pump up the economy just prior to a presidential election, which in turn had a positive affect on stock prices.”
In the second article by the authors they attempted to understand and explain the relationship between politics and stock market behavior. They focused on providing evidence of the relationship between economics, politics, and the four-year presidential cycle; and second, including an analysis of stock market performance during the 2008 period. They introduced a risk measurement for the stock market by arguing that the 2008 stock market crash should be considered an anomaly and concluded that the four year presidential stock market cycle is likely still intact. The goal of the article, according to the authors, was to provide evidence that risk may be reduced and returns may increase when an investor considers how economic policy influences stock market prices during the presidential election cycle.
The authors state what may seem obvious to even the most novice of stock market investors. They note that once a president takes office, they realize that to get reelected they must try to make the economy as healthy as possible four years later. Every president faces such circumstance and the authors note that “it is this consistency in the U.S. political process that also sets into motion fiscal policies that are frequently predictable and that often have a direct effect on the stock market.” In the discipline of economics, fiscal policy is defined as an increase or decrease of taxes and or government spending. The direction that fiscal policy takes can often be directly related to the state of the economy at the time a new president is elected.
The authors point out that it is not surprising to see incumbent presidents push for votes by proposing tax reductions and or increasing spending on specific government programs as an election draws near. In addition, an incumbent political party may also try to persuade the Federal Reserve to complement the administration’s efforts through monetary policy, by increasing the money supply and reducing interest rates. Such fiscal and monetary policies may be introduced as early as the end of the second year of the presidential four-year term. If the results are favorable and the economy responds positively, corporate profits will likely rise, and so will stock prices, just as the next presidential election is about to take place.
The authors also set forth the potential negative consequences of stimulating the economy by pointing out that the policies used to stimulate the economy and the stock market can also lead to inflation, which can be disconcerting to investors. If inflation occurs, a new president may be pressured to reverse the fiscal and monetary stimulus policies of the prior president, attempt to get inflation under control, and then hope to return to stimulus policies by midterm in preparation for the next election. Rising interest rates often lead to increased costs for businesses and consumers, which can slow spending and corporate profits, and pressure stock prices downward.
The articles point out and provide evidence that show the DJIA rises during the second half of the four-year presidential cycle. The authors point out the MFP within the four year presidential cycle. Such period begins on October 1 of the second year of the presidential term through December 31 of the fourth year. Such period performed significantly better than the unfavorable period, from January 1 in the first year of the presidential term through September 30 of the second year. The authors point out that the cycles of any type are not always perfectly aligned. Such alignment can be thrown off the authors point out when there are positive and negative macroeconomic events that can temporarily break a long standing the most favorable period cycle. They indicate that even with a history of positive market gains during such most favorable market periods from 1950 to 2004, the 2008 market collapse, precipitated by domestic and global economic events, was too powerful for the market to overcome. The authors conclude that while such economic 2008 market collapse was an isolated occurrence, they do not believe such event will be the only exception in the future. They believe that globalization and the Internet are at least two reasons for volatility and uncertainty in the years ahead. The authors sum up by stating, and we agree, the more the average investor knows about the interrelationship between politics, economics, and the stock market, the more informed they will be in making investment decisions.
We believe that the authors provide powerful evidence and a detailed discussion of how politics influence the stock market. As the authors point out, what they label as a most favorable periods and least favorable periods typically hold true within each president’s four year term barring exceptions where stimulus activities cannot overcome severe global and economic negative circumstances. So what does the upcoming last year of President Obama’s presidency hold for the stock market? It is true that President Obama cannot run for a third term as president as he is barred from doing so (and whether the public wants him or not). So, President Obama is not worried about getting reelected. It is also likely true that, President Obama would like a fellow Democrat to be elected as President. So, it is likely his fiscal policies will likely continue to boost the economy and the stock market.
If one follows the data presented by the authors of the above articles, 2015 will be a good year for the stock market unless a severe global or economic event occurs. And what about the much discussed interest rate increases that may start to occur in 2015? Well, such interest rate increases, however moderate they may be, will have a lagging effect on the market that would most likely occur in 2016 after the presidential election has occurred. If the overall market indexes gain next year, do not expect the markets to go straight up but experience volatility along the way. It is during such volatility on the downside that investors should consider establishing new positions.