Election Cycle Primer

The Most Powerful Market Cycle?

The Election Cycle

One topic has become a perennial favorite of The Stock Trader’s Almanac and it's a topic we have discussed before. Here is a primer for those not well acquainted with just how powerful a force it is in markets.

Called the most powerful short-term cycle, the Presidential or Election Cycle describes the economic impact that governments exert in their efforts to get re-elected. Whether Republican or Democrat, governments have found very inventive and effective ways of putting voters in the best possible mood to get re-elected over the last century or more. While the exact ways in which governments do this is not clear, the effect on stocks is undeniable (Click: Read more...)

The Most Powerful Market Cycle?

The Election Cycle

By Matt Blackman

One topic has become a perennial favorite of The Stock Trader’s Almanac and it's a topic we have discussed before. Here is a primer for those not well acquainted with just how powerful a force it is in markets.

Called the most powerful short-term cycle, the Presidential or Election Cycle describes the economic impact that governments exert in their efforts to get re-elected. Whether Republican or Democrat, governments have found very inventive and effective ways of putting voters in the best possible mood to get re-elected over the last century or more. While the exact ways in which governments do this is not clear, the effect on stocks is undeniable (see Figure 1). 

An examination of the last 29 election cycles between 1888 and 2004 revealed an interesting pattern. Put them together into a composite election cycle (next chart) and you’ll find a mid-term low at the end of September of the mid-term year (green arrow in year 2) and a high in December of the election year (red arrow in year 4) 26 months later.

Figure 1 – Composite cycle of the 29 election cycles from 1888 through 2004 showing how the Dow Jones Industrial Average has performed in each of the four years of the average (composite) election cycle.

Next, we developed a trading system to test the efficacy of buying and holding stocks through the pre-election period (green) versus buying and holding through the post-election period (orange). Here is how the trader would have fared who used it between 1902 and 2006 to trade the Dow Jones Industrial Average.

Pre-election versus post-election – A world of difference

Figure 2 – Comparisons of the returns of buying the Dow from the mid-term low (2 years before the election) and selling the election year high 26-months later versus the inverse of buying the election year high and selling the mid-term low 22 months later. This worked out to a ratio of more than 13:1 in favor of the pre-election trader.

To determine exactly how this has impacted the Dow, our trading system bought the index on the closing day of the first trading day of each period and sold at the close of the last trading day. Our pre-election period was determined by buying the low of the worst month in the mid-term year (September) and selling following the best month of the election year (November) 26 months later.

The post-election period was the remaining 22-months of the four-year cycle. Our timeline was 1902 through 2006.  

Just how powerful is it?

If the hypothetical pre-election cycle trader had purchased the Dow two years before each election and sold 26-months later on the last day in November he would have captured 93% of the gains over the 104-year period. This compares to a gain of just 7% for the trader who bought in January of the post-election year and sold 22-months later at the end of September of the mid-term year. That works out to a ratio of 93:7 or more than 13:1.

And this phenomenon isn’t limited to American markets. Results were even more skewed for the Canadian Toronto Stock Exchange Index (TSX).

Figure 3 – Pre-election versus post-election returns for the Toronto Stock Exchange (TSX) Index which has a large number of resource stocks especially energy and mining.

Buying the TSX two years before each U.S. election and selling in December of the election year would have yielded 97% of total TSX gains versus just 3% for the two-post election years between 1950 (the inception of the TSX) and 2006. Why? Since the TSX is a resource-based index and since government juicing of the economy is inflationary, commodities have performed very well indeed in the two years leading up to each election – proof positive that incumbent governments do whatever it takes to get re-elected even if it means a pay cut for us over time.  

But the similarity doesn’t stop there. In testing a number of international markets, we found that the U.S. election cycle impacted nearly every stock and commodity market from Sydney to Bombay. 

Best Years

Figure 4 – Chart comparing the percentage returns of buying the Dow at the beginning of each year and selling on the last trading day of the year. As you see, the pre-election year was by far the most profitable to be in the market.

And the best single year to be in the Dow? By only being invested the year before each election, the hypothetical trader would have captured a cool 60% of the total Dow gains.There hasn't been a losing pre-election year since the closing days of the Great Depression in 1939.This was followed by a distant 17% for those only invested in the election year. The worst year was the mid-term year which accounted for just 4% of Dow gains over the period. 

Next, we looked at the best quarters to be in the Dow. Not surprisingly, the best was Q2 of the pre-election year followed by Q4 in the mid-term year, which incidentally followed the worst quarter to be in the market. 

Best Quarters

Figure 5– Net Dow points gained (and lost) in the best (and worst) quarters between 1902 and 2006. Results calculated in Metastock.com 

Best Months

What about the best months to be in the Dow? Here we broke our periods down to all-years versus just pre-election years. While September has typically been the worst month followed by August, June and February in all-years, pre-election years are different in that September is the only negative month of the year. 

Figure 6 – Charts comparing the performance of the Dow in all years versus just the pre-election (year before the election) years between 1902 and 2006.

{For information on best quarters and best months found in backtesting, go to /content/view/82/58/#Primer }

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