- History suggests that US stock market returns are correlated with the presidential election cycle.
- The first 2 years of a presidential term have been associated with below-average returns, while the last 2 years have been well above-average.
- But there are some clear exceptions. So always focus first on the economy and corporate earnings.
About the expert
Jurrien Timmer is the director of global macro in Fidelity's Global Asset Allocation Division, specializing in global macro strategy and active asset allocation. He joined Fidelity in 1995 as a technical research analyst.
Fundamentals like corporate earnings, interest rates, and economic growth are the main concerns of the stock market. But external events may sometimes be correlated to stock returns, for instance, the 4-year election cycle in the US.
I have studied the election cycle and its potential impact on the stock market for many years, looking back to the 1850s. I recently updated this study and took the history all the way back to the very first election in 1789 (yes, there is stock market history that far back if you splice different series together).
Presidential elections and stock market returns
The "Presidential Cycle," as it is known, shows a consistent pattern in which the first 2 years of a presidential term have tended to produce below-average returns while the last 2 years have been well above-average.
Presumably, the reason for this is that during the first half of a term, a president's new agenda could take some time to work its way through the economy. It might even produce some indigestion for the market if it's not considered "market friendly."
But during the last 2 years, the party in power tends to be more inclined to focus its attention on getting re-elected, or so goes the general thinking. It presumably does this through fiscal stimulus and even monetary stimulus (at least it could have until the Fed became independent in 1951). This gooses the economy and creates a big rally that, presumably, is intended to ensure re-election of the incumbent party (or at least that's the goal).
The market's lackluster performance in 2018 followed by strong gains in 2019 certainly fits this pattern, with bulls hoping that 2020 could be more of the same. You can see the Presidential Cycle in the lower left panel on the chart below. In the lower right panel I show the forward return for the stock market based on various election outcomes, measured from the close of the October preceding the election to 2 years later and 4 years later.
The reason I show 2 years is because that's when the mid-term elections happen, which can change the power dynamic in Washington, which can, in turn, affect the market's momentum.
I sliced and diced it several ways, showing the outcome for all presidential elections (58 occurrences), a Republican win (24) versus a Democrat (24), to a "sweep" by the Republican party (16) or Democrats (19), to various forms of gridlock (president from one party and House and/or Senate of another). Note that since the party system was not "Republican vs. Democrat" in the early days, the various occurrences do not add up to the total number of elections since 1789.
Short-term differences, long-term similarities
What's interesting to note is that whatever the differences are in outcomes over the first 2 years following a presidential election (and there are many), they have all but disappeared by the time a full 4-year term has taken place.
For instance, on average over the 2-year period, the market does better following a Republican win (+8.3%) than a Democrat win (+5.8%), but over a full 4-year term the average difference virtually disappears and we are left with +8.6% vs. +8.8% for Republican presidencies and all presidencies respectively.
The contrast is even more extreme when there is a sweep. When the Republicans sweep, the 2-year average forward return is +12.2% and when the Democrats sweep it is a mere +3.4%. But again, after 4 years the difference in average returns is almost gone (+8.6% vs. +8.2%).
We also see a difference between the various gridlock scenarios. Republican wins without a majority in the House or Senate have produced an average 2-year forward return of only +1.1%, while Democrat wins with opposition in Congress have produced an average forward return of +14.5%. Again, over the 4-year term the difference narrows to +8.7% vs. +10.9%.
Part of this difference could just be the result of small sample size. For instance, there were only 6 instances of a Democrat winning the White House without taking control of both houses of Congress, including President Obama's second term in 2012 as well as President Clinton's second term in 1996. These were very strong periods for the market, producing annualized gains of +22% and +27%, respectively.
There were only 9 gridlock cycles on the Republican side, including George W. Bush's first term in 2000, right at the top of the tech bubble. That produced a 2-year annualized return of −25%. Ronald Reagan's first term in 1980 produced a 2-year return of −2% as the double-dip recession of 1980 and 1982 was still finding its bottom. But Reagan's re-election in 1984 produced a +26% annualized gain over the subsequent 2 years.
It's likely that mid-term elections play a role in creating a contrast between the 2- and 4-year returns. The political pendulum is always swinging it seems, sometimes quickly and other times slowly. While some mid-term elections reinforce a president's mandate, others cancel them out, mitigating whatever market momentum (positive or negative) was underway in the first 2 years.
It always comes back to fundamentals
But it could also just be that if you wait long enough, the long-term fundamentals of earnings and interest rates, labor growth and productivity, and the mean-reverting nature of an independent monetary policy, take over in driving long-term returns.
I think that's what ultimately is going on here. The economy—and therefore the market—is simply bigger than the direction the political winds are blowing. Plus, the mid-term elections tend to equalize any lopsided returns over the first 2 years.
It's a good reminder that while it is sometimes suggested that a particular president or party is "good" or "bad" for the stock market, ultimately, it's these long-term fundamentals that matter. While policy initiatives like taxes and spending can affect markets, so do demographics and an effective monetary policy.
From a longer-term market perspective, the upcoming presidential election is of course important, as the approaching demographic wave of an aging population increases demand for health and Social Security benefits, which are likely to result in ever-rising debt levels and the need for permanently low interest rates.
Nevertheless, it's my personal sense that the 2020 election will have less impact on the markets than some suggest. Ultimately, it's the long wave of economic fundamentals that drives the markets beyond any one election or any one party.