The Electionomic Trader Goes North

Impact of the U.S. Presidential Cycle on the TSX

By Matt Blackman – Senior Market Analyst for www.tradingeducation.com

Like a number of countries around the world, Canada has a parliamentary system and elections do not occur at pre-set times. A prime minister’s term can last longer than five years or be as short as a few months.  In the U.S. however, a presidential term is fixed. Like clockwork presidential elections have occurred every four years since the U.S. became a nation. 

This has led to an interesting phenomenon. Since the first elections more than 200 years ago, governments have learned that it is not politically expedient to have voters go to the polls under the cloud of a struggling economy with high unemployment. Political parties have a far greater chance of getting re-elected if their constituents are instead living in prosperity. As a result governments generally tend to make the tough decisions early in their administrations and saving programs that stimulate the economy, as voters get ready to head to the polls.

This practice has had a quantifiable affect on U.S. markets and since it is the single largest global economy, what impact has it had on other international markets?

Do American elections impact the TSX?

In an effort to answer this question, Matt Blackman, senior market analyst for www.tradingeducation.com a free educational website for traders and investors, researched the impact of the U.S. election cycle on the Toronto Stock Exchange (TSX) by designing a trading system to trade the historic highs and lows.

The system is relatively simple. Given that governments have tended to institute tough measures to cure economic ills early in their mandate and save the stimulative programs and policy initiatives till near the end of their terms, the electionomic trader buys at the mid-term election term low in September 22-months after the election, holds for 26-months and then sells at the end of November of the election year.

For comparison purposes, the inverse system buys the election year high in November and sell 22-months later at the mid-term low in September. If there was no election cycle impact and if governments did change policy in an attempt to improve economic performance leading into each election, the two systems should prove to be approximately equal.

First we looked at the Dow Jones Industrial Average (DJIA) between 1902 and 2006. Over the period of our test ending October 2006, the Dow gained a total of 11,612 points, which we will call the buy and hold (B&H) total. How would the electionomic trader have performed?

Figure 1 – Here is how an investor would have fared had he bought the Dow Jones Industrial Average at each mid-term September presidential cycle low two years before each election and sold at the end of November each election (26 months later) between 1902 and 2006 versus buying the election year high and selling the mid-term low 22 months later – an advantage of 13:1 for those buying before the election.

Chart by www.tradingeducation.com

As we see from Figure 1, there was an advantage of 13:1 for buying the Dow two years before the election and selling the election year high versus the inverse method buying immediately following an election and selling approximately two years later.

Only in Canada, Eh?

For those buying the TSX since it was created more than 50 years ago at the U.S. presidential cycle mid-term low in September and selling the post election high in November 26 months later would have captured more than 97% of the TSX gains between 1950 and 2006 (the TSX is a younger exchange than the Dow). This works out to a ration of more than 32:1 (see Figure 2).

Figure 2 – Graph showing returns for the investor buying the TSX at the U.S. presidential cycle mid-term low in September and selling 26 months later at the end of the November of the election year versus the investor who bought the election-year high and sold 22 months later at the mid-term low. Chart provided by www.tradingeducation.com

Table 1 – Trade results for a system that bought the TSX at the mid-term U.S. presidential cycle low and sold the election year high 26 months later versus the inverse of buying the election year high and selling the mid-term low. The median pre-election trade returned nearly 38% versus the median post-election system trade that lost 1%. The table also shows results for the best trades and worst trades for both methods.  The electionomic trader captured more than 97% of the total buy & hold over the period. Chart provided by www.tradingeducation.com

Results Speak

The benefits of being an electionomic trader speak for themselves. Our tests showed that U.S. elections have had an even stronger impact of the TSX than on the Dow Industrial Average, a fact that many Canadian investors may not appreciate. What is striking is that by buying two years before U.S. elections, investors would have been able to capture nearly all gains in the TSX by only having been invested a little more than half (52%) of the time, effectively doubling the returns for a buy and hold strategy over the same period while reducing the risk of being caught in a drawdown situations. Studies show that some of the biggest bear markets in history have come in the heels of American elections. 

We also looked at a number of other international indexes and for majority found a distinct benefit for using the U.S. election cycle to trade.

It is important to point out that there were 14 trades for the TSX since only one trade per four-year period is generated. It is important to stress that the electionomic trader is not a stand-alone trading system rather a backdrop to augment your favourite trading methods.

But our studies show that those who ignore the impact of the enormous U.S. political machine in their efforts to get re-elected every four years, do so at their peril, no matter what stock markets around the world they trade.

Matt Blackman is a market analyst for www.TradingEducation.com, a free educational website, and is a technical trader, author, reviewer and keynote speaker whose work has appeared in a number of major financial publications, websites and newsletters. He is also the host of www.Electionomics.com a website devoted to investigating the impact of elections on stock markets around the world.  He is a member of the Market Technicians Association (MTA) and Technical Securities Analysts Association (TSAA).