Since
the beginning of the twentieth century, pre-election and
election years have greatly outperformed the
post-election and mid-term years. In fact, stock market
performance during the two years leading up to each
election versus the two years following works out to a
ratio of more than 3.5 to 1. Historically, the Dow has
experienced 77.56% of its gains in years three and four
compared to just 22.44% in years one and two of the
Presidential Cycle.
Just
twelve years ago, on July 17, 1995 the Nasdaq Composite
Index closed above the 1,000 mark for the first time
ever. The S&P500 reached the same milestone on February
2, 1998 when the index closed at 1001.27. The next few
years would be good for both with the Nasdaq jumping
more than 400% over the next 56 months to hit a high of
5.132.52 (March 10, 2000) while the SPX added another
50% over the next two years hitting a high of 1,527.46
on March 24. By this point the Dow Industrials had
already seen its best day recorded to that point,
closing at 11,722.98 on January 14.
Figure
1 – Weekly chart of the S&P500 showing the pre-election
and election years (between green dashed lines), the
March 2000 high. The index is still more than 7% below
its all-time high.
Like,
2007, 1999 was a pre-election year which has
historically outperformed the other years in the
four-year election cycle by a wide margin. Election
years are the next best year but 2000 failed to live up
to expectation as both indexes lost ground. It would
prove to be the start of a 2-year bear market that would
see the Nasdaq lose nearly 80% of its value by October
2002 while the SPX was nearly cut in half.
But
true to form, the next two years leading up the
Presidential Election 2004 did not disappoint. March
2003 was the official beginning of a rally that lasted
not only through the next two years but with one major
hiccup, is still in play.
There
were large differences between the two previous
pre-election periods. In 1999-2000, the market had been
engaged in a bull market for 18 years that was capped
off by an exuberant blow-off rally that pushed indexes
into the stratosphere before they fell off a cliff. The
next pre-election period coincided with the end of the
recession and an ensuing economic recovery. But as we
move into the latest pre-election period, the rally is
getting long in the tooth. The economic recovery is also
facing growing headwinds that include a mortgage bubble
that promises to get worse before it gets better.
Figure
2 – Meanwhile this weekly chart of the Nasdaq Composite
Index showing pre-election and election years (green
dashed lines) is still more than 52% off its all-time
high.
There
is now growing evidence that unlike a hoped for soft
housing landing, sub-prime and alt-A problems are the
tip of an iceberg that will put a much wider group of
homeowners than originally thought under increasing
pressure. In spite of what industry cheerleaders with a
vested interest in keeping optimism alive have been
saying, the news just keeps getting worse. Florida and
California, the two poster child states for housing
price appreciations until last year now lead the country
in foreclosures and record high inventories of unsold
homes. And contrary to what many analysts have regularly
repeated, the problem is not limited to those with shaky
credit histories buying lower priced homes.
It’s no
longer a matter of if but when this problem begins to
seriously impact stock prices. But don’t bet against the
market when there is an election on the horizon. Based
on history, government minions will do their level best
to keep happy faces firmly glued on all they can
influence and the consumer merrily spending as the
election looms. And like just about every other
pre-election period in history, these efforts have so
far been successful.
So how
long can stocks keep the drive alive in the face of the
increasingly powerful downdraft? In 2000, they began to
peter out early in the election year. If the correction
doesn’t come in the fourth quarter this year, it will be
increasingly challenging to keep the market balloon
aloft into mid-2008; that is unless Ben Bernanke makes
good on this treat to throw money out of helicopters.
But as
long as consumers can keep spending at the malls, the
market should keep on rising leading into the next
election. Since inflation is the government’s friend,
there is a good chance that inflation fighting by the
Fed will take a back seat to generating further economic
prosperity and that means interest rates shouldn’t rise
much. However once the election is over, there will be a
lot of tough decisions to be made and if history is any
guide, the markets will begin to take it on the chin.
