Tricky business

By David Berman
Globe Investor Magazine,
November 18, 2008
Photograph by Bettmann/Corbis; Graph by Douglas Coull/The Globe and Mail (source: Thomson Datastream)

The world is excited about a new president moving into the White House, but investors might want to hold back on the celebrations-two years, to be exact. That, at least, is what the presidential cycle of the stock market suggests-and though this may be one of the quirkier stock market predictors, it is also one of the more reliable ones.

The cycle goes like this. The first half of the four-year presidential term tends to be bad for U.S. stocks, with the second year particularly dismal. But stocks tend to shoot higher in the third year and continue to perform well in the final year. The second term of Richard Nixon's administration, between 1973 and 1976, provides a good example of what's at stake. During the first year of his second term, the S&P 500 fell 17.4%. During his second year, the index plunged 29.7%. After Nixon resigned and his vice-president, Gerald Ford, took over, things picked up for investors: The S&P 500 surged 31.5%. And, in the following final year, the index rose an impressive 19.1%.

Over the longer term, the numbers are similarly compelling. In the 12 presidential cycles between John F. Kennedy and George W. Bush, the S&P 500 has risen, on average, just 5.5% in the first year of a president's term, fallen 2.6% in the second year, risen 19.9% in the third year, and risen 10.8% in the fourth year. During those years, there were wars, recessions, inflation scares and even assassinations, but the cycle persisted. Why?

"One possible underlying reason is that stock prices may decline following an election as the new president takes unpopular steps to make adjustments to the economy," says Wing-Keung Wong, a professor at the National University of Singapore.

Or, to put it another way, presidents get down to business in their first two years, then focus on re-election prospects in their third and fourth years. Of course, like any stock market predictor, there are complications here. The cycle works best under Republican administrations. And, let's face it, things like tech meltdowns and credit crunches can do to a president's power what a strong wind can do to paper airplanes. For example, Bill Clinton's second term saw the S&P 500 rise 31% in the first year, during the dot-com euphoria, but fall 10% in his final year, when the bubble burst.

With the global stock meltdown, it looks like the cycle is off again this year. But if the pattern restarts again, 2009 should be a ho-hum year at best for stocks, and 2010 could be another disaster in the making. But, come 2011, investors should be chomping at the bit.