The Presidential
Market Cycle Theory
by Frank Holmes
Chairman & Chief Executive Officer
U.S. Global Investors Inc.
Halfway into the fourth year of this high flying stock market,
many investors believe the market is overdue for a correction. Indeed, while
the S&P 500 Index is up more than 13% as of this writing, the market
has had two significant one-day drops, first in January, and more recently
on June 15th, when the Dow fell 207 points. The truly startling fact about
stock market returns so far this year is that while the large-caps have
done very well, the majority of smaller stocks in the weighted indexes of
the S&P 500 and the Nasdaq have seen only marginal returns. Large-caps
in the S&P 100 Index have returned 17% while mid-cap stocks, as measured
by the S&P 400 Index, have only returned 4% as of this writing. And,
small-cap stocks, as measured by the Russell 2000 Index, have only returned
0.6%. Large-cap gains have distorted the picture: Mid- and small-cap issues
have only seen modest gains.Great
returns for '98 seem unlikely, especially if you adhere to the Presidential
Market Cycle Theory. According to Presidential Market Cycle Theory, the
economy fluctuates in fairly regular patterns over the course of each presidential
term: The first two years after a presidential election tend to be weak,
while years three (the pre-election year) and four (the election year) offer
strong returns for the stock market. The reason: Politics, of course. The
party in power, Democrat or Republican, wants to remain in power. So, during
pre-election and election years, the incumbent government increases the
money supply and popular government programs, while reducing taxeswhatever
it takes to keep business and the market moving up. Prosperous business
people, employed workers and moderately contented taxpayers add up to re-election.
No rocket science there.In
the lackluster part of the cycle, the years just following the election
year, the President makes the difficult decisions, hoping they will be forgotten
by the time elections roll around. These decisions, usually involving more
taxes, spending and regulation, eat into business profits. Because stock
prices follow corporate earnings, these decisions have a negative impact
on the stock market.In
the past fifty years, stock market movements from high to low to high again
have run almost uniformly in four-year patterns. In fact, there have been
13 identifiable complete stock market cycles showing a high and a low since
the end of World War Two. We're in the 14th cycle now. Further, of the 13
periods, 92% of the cycle "lows" occurred in the first and second
years of the presidential term. Similarly, the "highs" should
occur in the third and fourth years (the election year) of a presidential
cycle. Do they? In approximately 85% of the four-year cycles, the high point
was reached in the third or fourth year.
Politics do have a significant effect on the stock market (were
you watching bond prices during the Monica Lewinsky scandal?), but does
this theory really work? And if so, why aren't we all boosting our returns
by keeping our money in stocks in pre-election and election year markets,
and switching our money into Treasury bills in the off years?Because,
like all theories, this one has its inconsistencies. For example, '97 should
have been a down year, according to theory, as it was a post-election yearyet
the S&P posted returns of more than 30%. You wouldn't want all your
money sitting in Treasuries during that kind of run, would you?Statistically,
'98 should be an underperformer, as it is a mid-term year. Yet, there is
a tremendous amount of liquidity in the market, investor confidence is high
and inflation is low. That generally spells good returns for the stock market.
While the turmoil in Asia has some investors worried, the effects of Asia's
economic troubles have not yet fully registered on the U.S. stock market.Presidential
Market Theory predicts that '98 will be a poor performing year, but will
gain momentum as the pre-election year of '99 rolls around. According to
the theory, years '99 and 2000 should post significant returns for the stock
market. Whether or not they will remains to be seen.Remember,
there is never one "best time" to begin investing in the stock
market. A key to successful investing is the length of time you are prepared
to remain invested, not when you begin to invest. You should also diversify
your portfolio with an asset allocation strategy that meets your risk profile
and long-term financial needs. Programs which involve dollar cost averaging
reduce the risk that you buy at the top of the market and keep you investing
regularly over time, in both up and down markets. That discipline can really
pay off, and takes the emotional "sting" out of buying and selling
at the wrong time.