Opinion: Market’s ‘presidential cycle’ points to weaker stock prices through late 2022

The Cycle is based on the undeniable fact that incumbents want to be re-elected. The implication is that any economic medicine that needs to be taken is swallowed earlier in the presidential term — in hopes that the economy will be soaring once the subsequent presidential election comes around. That implies that the stock market will produce below-average performance in the first half of a president’s term and above-average in the second.

This is largely consistent with the historical record. Since the Dow Jones Industrial Average
DJIA,
-1.20%
was created in the late 1800s, the U.S. stock market’s average price-only return in the first two years of the four-year presidential term is 5.6% per year, versus 9.3% in the third- and fourth years. (Note that, following the lead of many past researchers, these calculations focus on fiscal years beginning Oct. 1. On this assumption, we currently are about halfway through President Joe Biden’s first year.)

The weight you put on this difference between the first and second halves of the Presidential Cycle depends on how much of a gambler you are. That’s because this seasonal pattern exerts only a weak gravitational pull during any one president’s term. To bet in an intelligent way on that gravitational pull, you would need to do so consistently over several decades.

Just take the four years of Trump’s term. Contrary to the historical pattern, the first half of his presidency was far and away better for the stock market than the second. The Dow produced an average return of over 20% over the first two years of his term, versus average of just 3.0% in the third- and fourth years.

So by no means is the Cycle a guarantee. Even if the future is like the past, the Cycle represents tendencies that emerge only on average over many presidencies.

Slicing and dicing the data

Further patterns emerge when we focus on individual years rather than first and second halves of the presidential term. As you can see from the chart, below, the best year by far of the four-year term is the third year, while the worst is the second year. In contrast, during the first- and fourth years of the Cycle there are statistically insignificant differences between the DJIA’s returns and the all-year average.

If the future is like the past, the stock market will suffer during the 12-month period beginning this Oct. 1, and then post an above-average performance beginning in the fourth quarter of 2022.

The likely source of this year-two weakness and year-three strength is the midterm elections, according to an academic study authored by Kam Fong Chan, a senior lecturer in finance at the University of Queensland in Australia, and Terry Marsh, an emeritus finance professor at the University of California, Berkeley, and CEO of Quantal International, a risk-management firm for institutional investors.

Before the midterms, they argue, the stock market struggles because of the considerable economic policy uncertainty caused by not knowing whether political control of Congress will change. Once that uncertainty is resolved, near the beginning of the Presidential Cycle’s third year, the stock market typically bounces back. The professors report that their theory is supported by historical patterns in the Economic Policy Uncertainty (EPU) index that was created several years ago by three finance professors: Scott Baker of Northwestern University, Nick Bloom of Stanford University and Steven Davis of the University of Chicago.

The bottom line? The Presidential Election Year Cycle is forecasting U.S. stock market weakness in the 12-month period that begins in just over six months’ time, followed by strength beginning in the fourth quarter of 2022.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

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