To better understand this issue of how the US election is impacting financial markets, we take help from Yale Hirsh and his theory known as “Presidential Election Cycle Theory.” According to this theory, the US financial market is particularly weak in the year following the election of a new president, and then it reaches its higher strength in the third year of the presidential term. Analysing the data from the end of the Second World War to nowadays, we can see that the DJIA records an average return of 3.9% in the years which follows an election against an 8.09% average for all other years.
What are the reasons beyond this cycle? Simple: in the third year of a presidential mandate, the occupant of the White House is aware of the fact that the elections are approaching, and then he tries to approve laws which are market-friendly while unpopular reforms are avoided; that is done in order to make sure to get the votes needed to be re-elected. What happens instead in the first year after the election of a president? Financial markets hate uncertainty, and that’s why the market does not like a new president, they do not know what to expect from him or her.
Precisely because they hate uncertainty, financial markets tend to prefer the election in which the incumbent president is still a candidate. According to Stephen Suttemeier (technical research analyst at Bank of America Merrill Lynch), in the years when the incumbent president is running for a new term, the S&P 500 index has risen on average by 12.6%. During the years when the incumbent has not run for re-election, the same index recorded an average loss of 2.8%. That analysis has been performed using data from 1928 to 2016.
This theory is not scientific; it is not a natural law that is respected with absolute regularity. There may indeed be other factors that explain the performance of the market. An example of the failure of this theory was the third year of the second presidential term of George W. Bush. I am sure that the readers will agree with me that 2008 was a “peculiar” year and that it’s dynamic may have suffered from some factors not strictly related to the Presidential Election Cycle.
So, what should we expect for the second half of 2016? Difficult to say, as always in the financial markets. One issue which adds uncertainty is the fact that Obama is not a candidate in the incoming elections; moreover, the presidential cycle seems not to have worked very well during the last presidency of Obama. In the first two years of the presidential term in progress, we have seen a good performance of the S&P 500, thanks to policies such as quantitative easing. The third year is instead characterised by a rather weak performance. This fact may be due to various causes, such as worse economic performance than expected and the crisis in emerging markets with its consequences on the price of commodities. If we consider all this, plus the new monetary policy of the Fed, we can expect a very volatile second half of 2016.