If you are like me, you were hoping to get a break from political news after the mid-term elections just ended.

The break didn’t last long.

The presidential campaign season is well underway, with former President Donald Trump already declaring his candidacy. In the coming weeks, we are sure to hear about other Republicans joining the race. And on the other side of the aisle, we expect to hear from Biden on his reelection intentions as well as a slew of other Democrats.

Investors with some loose money and a taste for risk might think about betting on the outcome.

But what is there to do?

This is What Some People Might Do

Let’s look at an example. Some may believe that stocks in fossil fuel companies are more likely to prosper under Republicans than Democrats. Renewable-energy firms might do the opposite. In fact, it’s hard to find an industry that isn’t influenced by national policy set in motion by presidential elections.

If you felt so inclined, a gambler’s mentality should start by studying candidates’ platforms. Looking at the industries that might benefit if that candidate wins is one way to do it. For instance, if you thought Trump was going to win, and that he would be able to get increased spending for the military, you should have bought defense stocks.

Investors seeking funds that are devoted to the election cycle probably will not find any. They can bet the broad market through index funds, or use funds devoted to specific sectors. Those with really strong feelings and a thirst for risk can use options on individual stocks or ETFs. With options, you can bet on market losses as well as gains.

Financial advisors like myself are quick to point out the dangers of that approach. We tend to suggest that investors focused on college and retirement do best with a broadly diversified portfolio designed for the long-term. Betting on Washington is probably a loser’s game in the long run.

Still, holding a few broad-market index funds for decades is pretty boring, and investors get FOMO. I get it. From my experience, people get caught up in the headlines and think there are certain “plays” to be had. I suppose there is nothing wrong with betting on short-term swings… if you can afford to lose (and admit you could potentially be wrong).

Studies and Theories

So how do markets behave during the four-year presidential cycle? There’s lots of history on that.

A study by Yardeni Research, for instance, looks at market performance in each of the 4 years of a Presidential cycle. Data from 1928 through 2021 shows that the S&P 500 has returned an average of 13.5% in the third year of the presidential term. That beats the 6.7% in year one, 4.3% in year two, and 7.4% in year four.

OK great. So looking in the rearview mirror, the third year of a Presidential cycle has traditionally been bullish for stocks. The numbers certainly have been impressive. Here’s a visual for you that shows 70 years of data in chart format:

Other studies have been done, and those studies evolve into various theories as to why this happens the way it does. Interesting to read, but in theory very difficult to try and trade.

Looking at individual sectors, studies also show that the best-performing sectors in the third year have been information technology, energy, and industrials. The worst sectors historically have been financials, consumer staples, and utilities. Does past performance guarantee future performance will be the same? Ummmm… you won’t catch me saying that. Nonetheless, it’s interesting to see the history from prior cycles.

Studies further show that pro-business Republican policies don’t necessarily translate into better results than pro-regulation Democratic ones, according to data by the Retirement Researcher. From 1926-2019,  the S&P500 average annual rate of return under Democratic presidents was 14.94%. Under Republicans, it was 9.12%, about 5.8% less per year on average.

But the results are skewed by a few extreme periods, such as the Great Depression and the following few years. Another factor to consider is what happens in a divided government (ie. when Congress is controlled by the opposite party of the President)? These numbers tell a different story.

As you can see, market performance has been about the same under the two parties when the situation is unified. Historically, the disparity comes when the government has been divided.

The interesting question is still – Why is the second half of the term better than the first?

Maybe it is a coincidence. Maybe not.

Here’s one popular opinion: our elected leaders want to get the bad news out early in their terms so they or their party stands a better chance of getting reelected. Also of note, the Federal Reserve has pursued a more accommodative policy during the final two years of a president’s term. Policymakers have been reluctant to assume a restrictive stance in the months leading up to a presidential election.

Can You Time It?

As good as it feels to have numbers on our side from a historical perspective, there is no shortage of talk about recession looking in the year ahead. In fact, I see a lot of market prognosticators fearing the worst. Note – it doesn’t mean they are right!

Back to the first two years of a cycle, versus the second two years. Stocks probably do worse at the start of a presidential term because of uncertainty about the effect of new leadership and policies. It may not be about whether the new policies are good or bad, rather it is about the upcoming uncertain environment. Other factors come into play, but this is one main hypothesis.

But my word of caution: any bet on relative short-term market moves is speculation, not investing. Don’t use the stock market to bet, it’s probably not going to work out well. Instead, use the stock market as a vehicle for long-term compounding growth.

Brandon