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The Presidential Cycle: 2nd Year Performance at Trader’s Narrative

While the current cyclical bull market rally has been typical of what follows bear markets, the rally has been in direct conflict with the stock market’s presidential cycle. This is the pattern where the stock market responds to the changes made by a new US president.

On average, the first two years of the presidential cycle are the weakest with the S&P 500 Index performing poorest in the first year of the four-year election cycle. The third and fourth are the best historical years with the 3rd year being the best.

Here is a chart courtesy of McClellan Financial comparing the present rally with the presidential cycle pattern:
presidential cycle Apr 2010
Source: McClellan Financial

As you can see, if the market were performing exactly in line with the average historical pattern, by now it would be just barely above 1000. But it is currently 24% above where it was in November 2008 when Barack Obama was elected president 2008. Going forward, the average performance of the second year has been flat (sound familiar?).

The third year is when the fireworks arrive with an average return of almost 30%. For more details on the second year of the presidential cycle, see this article from Hussman Funds.

election cycle returns quarterly Hussman Apr 2010
Source: Business Cycles, Election Cycles and Potential Risks

As the previous year demonstrated, where we are in the election cycle does not dictate how the stock market will perform on any given year. On average, there is an effect that comes about from new legislation and fiscal policy but it is just one of many variables.

The current stock market performance is however totally in keeping with its historical vast outperformance during Democratic presidencies. Yes, contrary to popular belief, Wall Street prefers Democrats by a wide margin.

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