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Here's something that Democrats and Republicans have in common: they can both be stock market poison in the first year of a presidential administration.
It's by no means a done deal that the U.S. market will fall next year, which will be the first for the winner of the U.S. presidential election coming this November. But there's an awful lot of history to suggest that investors should worry less about which party wins the race than how well positioned their portfolios are for a possible market decline.
The mutual fund company Mackenzie Financial recently published data for presidential cycles going back to 1901 and the results show that there have been 13 stock market declines in the first year of an administration. There have been 26 presidential cycles in total over that period, which suggests a 50:50 chance of share prices falling in 2009. The explanation here is that stock prices can be negatively affected by uncertainty about what measures the new president will adopt in terms of taxes, budgets and economic stimulus.
Call it a buying opportunity if the market does fall. According to U.S. presidential cycle theory, returns improve gradually and then peak in the third year of an administration. The overall scorecard: total gains of 218.7 per cent in the first two years of an administration, and total gains of 570.1 per cent in the second two years.
Applying U.S. presidential cycle theory right now is complicated by a couple of factors, one of them being that 2007, the third year of the current cycle, was a poor one in which the S&P 500 stock index gained only 3.5 per cent in U.S.-dollar terms. The current year is looking even worse, with the S&P 500 down almost 10 per cent through the first six weeks.
A bad January is often an indicator of a poor year for stocks, but the presidential cycle argues against this. Mackenzie's analysis found that in the fourth year of the presidential cycle, the election year, there have been eight instances of the market falling and 18 examples of it rising. Since 1945, however, there have only been three down years during this segment of the cycle, and the worst of them was the 9.3-per-cent drop in 1957 (Eisenhower was the president at the time).
Behind the recent bout of stock market jitters is a rising level of concern about the possibility of a U.S. recession. Couple that with the potential for a bad year in 2008 as a new president takes over and you end up with a bleak near-term outlook for stocks. The counter-argument is that stock markets tend to start snapping back before a recession is over. Therein lies an opportunity. At least one analyst has recently likened the bearish sentiment on the stock markets to both 2002, a terrible year for stocks, and 1990, which was a recession year. Research shows that in previous cases where the markets have been hit as hard, the average gain in the following 12 months was 28 per cent.
If you buy this line of thinking, then it's time to forget about the president cycle and start buying U.S. stocks. You'll be in a position to benefit when the markets rebound from their current slump and, if that doesn't work, there's always hope that the new president's third year in office will work its usual magic.
Rob Carrick has been writing about personal finance, business and economics for more than 12 years.