The Election Cycle – Best Years

by Matt Blackman

In our continuing research on the 4-year election cycle, we performed a number of tests to compare different periods of the election cycle. In this section we compare the yearly performance of the Dow Jones Industrial Average from the mid-term year of 1902 to the mid-term year 2006. Here is what we found. 

If an investor had purchased the Dow on the first trading day of each of the 4-election years and sold on the last trading day of the year between 1902 and 2006, they would have enjoyed the following results. 

Figure 1 – Breakdown of Dow performance for holding the index during each of the 4-election years. As you can see, the pre-election year outperformed the other 3 years by a wide margin. In fact by only owning the index during the pre-election year, you would have outperformed owning for the other 3 years together.  

Next we examined how the latest 4-year cycle differed from the historic relationship. Due to the fact that the pre-election year occurred following significant drops in 2001 and 2002, pre-election year 2003 actually outperformed a buy & hold strategy buying in 2002 and selling in October 2006.  

Figure 2 – The latest 4-year election cycle showing performance in each of the years. As you can see, the mid-term year (to October 31) moved into second place from last place in Figure 1.  

Takeaway

It has not been a good idea to bet against the pre-election year when playing the stock markets. But it appears that the stimulative economic pumps were turned on early this time around, probably due to the anticipated challenge Republicans would face from Democrats in the mid-term elections.  As it turned out, stimulating the economy was not enough to win the day for the incumbents due not to a poor economy, but more to the dissatisfaction with progress (or more accurately the lack of it) in the Iraq war.  

If this is the case, the government may have blown its economic ammunition early in the game leaving less to be used when the usual economic lift comes in the 3^rd and 4^th years (2007 and 2008) as the next Presidential election approaches.  Could it mean that that this pre-election year 2007 will be more muted? Given the uncharacteristic strength in markets during the mid-term year and the fact that a number of challenges face the economy like a housing melt and contracting economic cycle this time around, the probability for weaker than average performance is high. 

Stay tuned for more.