Presidential Cycle Effects With a New President

Longtime readers know that I do a lot of research related to the Presidential Cycle Pattern, which is based on the premise that the stock market shows a lot of similarity to the same points in prior presidential terms.  The PCP is calculated by averaging together the price history of the SP500 in 4-year chunks of time.

There are also different permutations one can create for the PCP, such as for Republican vs. Democrat presidents (which is not very useful) and for first term presidents versus incumbents.  This week's chart shows that latter variation, and it reveals that there is a big difference between getting a new president from a different party versus reelecting an incumbent.

In the chart above, the green line is the average performance for when there is a new president.  Yes, I know that President-elect Trump will be having his second term starting in January 2025.  But for the purposes of this analysis he is considered a first term president.

The reason I make that claim is that in the 30 years I have been doing this, I have seen a repeating theme where a new president typically spends the first 2 years "discovering" that things are even worse than he told us during the campaign.  Each week there is a new revelation of some crisis condition left to him by the prior administration, and a claim that the "only solution" to these myriad problems is whatever package of taxes, tax cuts, spending, reform, etc. that the new guy wants to get Congress to pass.

This is important because investors tend to get bummed out by hearing that things are worse than we all thought.  And that makes people incrementally less interested in investing.

When an incumbent president wins (or incumbent party candidate, as in Bush 41), he tends not to spend very much time blaming his predecessor for everything because he was the predecessor.  And generally speaking, the stock market tends to do well in the first year of an incumbent's second term, in part because the stock market and the economy had to be doing well going into the election for that guy to get reelected.  So we see a big difference in the PCPs in the chart above for first versus second term presidents, especially during the whole first year.

We also see a difference in the period right after the election.  When a new party candidate is elected, Wall Street typically celebrates because, "Hooray! Change!"  But that celebration typically wears off by around inauguration day, when people realize that the new guy has been in office for a whole day and he has not fixed everything yet.  Plus the wrangling with Congress starts in earnest then, leading to doubts about how the fights will turn out.  Wall Street hates unknowns.

Back in 2020, things worked out a little bit differently, and the stock market spent President Biden's first year in office cruising higher.  But it is worth noting that at the time of the election, the Fed was pumping $1 trillion per month of QE4 into the banking system, and QE lasted all the way until early 2022 when the Fed hit the thrust reversers and started doing quantitative tightening (QT).  That rather abrupt change in Fed action served to wipe out almost all of 2021's gains.

It is worth noting in this lower chart that by the time we get to the 3rd year of a presidential term, the big differences we see between 1st and 2nd term presidents largely disappear, and the market trends higher almost universally in 3rd presidential years.  Exceptions to this "rule" include 1931 during the Great Depression, and 1939 when the Wehrmacht was marching through Poland.  Outside of conditions like that, 3rd years are always up years.

And by the time the next election year arrives, the early differences in performance between 1st and 2nd term presidents get made up.  So any upcoming difficulties for the stock market during 2025 will be forgotten once 2028 gets here.

The big bullish expectation about Trump's upcoming inauguration is that he is going to usher in a great new era of governmental efficiency, low taxes, lower spending, and deregulation which will cause the economy to do amazing things.  But if Mr. Trump really is successful at curtailing government deficits and getting us to a balanced budget, that is historically a bearish factor for the stock market, as discussed here back in October.  And if any presumption about the market's future gets everyone all leaning too far one way, well we know what can happen then.

In other words, enjoy the party until inauguration day, and then get ready to put on your trading shoes.