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Chart In Focus

Entering the 3rd Presidential Year

Chart In Focus
November 05, 2010

The first two years of a president's term in office typically see a flat market, on average.  Some have been up, some have been down, but when we average them all together the typical market response is to chop sideways until the mid-term elections.

When it comes to analyzing the effect of the four year election cycle on the stock market, I like to measure each of the years as starting in November instead of January.  The reason is that the stock market reacts to the election results as soon as they are known, rather than waiting for the victors to be installed in office. 

The first two years of a president's first term in office tend to be negative for the stock market because presidents try to cram all of the bad stuff into the first two years.  That way, they can spend the last two years telling us all how they have fixed everything, and running for reelection. 

This week's chart looks at the SP500 during President Obama's first term, and compares it to the SP500 during Bush(43)'s first term along with our Presidential Cycle Pattern (PCP).  The PCP is derived by chopping up the SP500's price history into 4-year chunks of time, and then averaging together the market's performance.  When analyzing the PCP, the direction of movement is far more important than the magnitude.  All 3 plots are set to an initial value of 1.00 as of the presidential elections. 

Presidents Obama and Bush each saw different challenges in their first two years.  Both inherited an economy that was in recession.  The stock market in 2001 had to absorb the impact of the 9/11 attacks, and in 2002 we had the collapse of the tech bubble along with the run up to the 2003 war with Iraq.  Those events definitely bent the price plot lower, but there was still an evident correlation to the shape of the Presidential Cycle Pattern. 

One additional difference in Bush's first term was that the Federal Reserve was still trying to fight inflation that was not evident, but which was thought to lie "over the horizon".  The Fed Funds target was still at 6% in January 2001, versus "0 to 0.25%" in January 2009.

Looking ahead, we are now in the 3rd year of the current presidential term.  Third years are nearly always up years for the stock market.  The last time that the market was down in a third year was in 1939, when Hitler's armies were marching through Poland.  Looking back before the 1930s, it was quite normal for a president's third year to be a down year for the stock market.  1903 and 1907 saw two of the worst bear markets in history, and each was a third presidential year.  1931 was also a third year. 

The passage of the 20th Amendment to the U.S. Constitution in 1933 changed the political calendar in dramatic ways.  That amendment moved inauguration day up from March to January 20, and ended the old practice of having a lame duck Congress for a year before installing the next one.  Now, both the new president and new Congress take office at about the same time.  Because these changes altered the political calendar so profoundly, the effect on the stock market is different and so comparisons to periods before that amendment do not work as well.

It is also important to understand that being in the third presidential year does not completely immunize the market from problems.  The stock market saw a big crash in 1987, even though it was still an up year overall.  But the stock market's normal period of seasonal strength from November to May is especially effective in third presidential years, and it should be so again this time, especially with the Fed being so accommodative.  

Tom McClellan
Editor, The McClellan Market Report

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