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Don't expect the markets to crash in 2010 (if the Presidential Election Cycle Theory holds)

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May 18, 2010 – Comments (4)

I came across an interesting statement in BusinesWeek magazine (which is much better now that Bloomberg has taken control of it BTW) yesterday.  The statement that I am referring to was made by the famous market pundit Jeremy Grantham, who is not a raging bull by any stretch of the imagination.

He doesn't expect to see a crash in the stock market any time in 2010.  According to Mr. Grantham, there has not been a serious decline in the stock market during the third year of the Presidential cycle since 1932.

That interesting comment spurred me to do some research on the Presidential Election Cycle Theory. The theory was originally developed by the author of the Stock Trader's Almanac, Yale Hirsch.  It is quite interesting, though I don't think that any theory like this can be taken as gospel.

Here's a table from a SeekingAlpha article from a couple of years ago (link) on the subject that breaks down the stock market's returns during the four year term of Presidents.

Here's a chart that illustrates the same pattern:

As you can see, the third year of a President's term in office for some reason usually yields the best returns in the stock market.  I suppose that this trend makes some sense if you think about it.

New Presidents likely try to cram the promises that they made during their election campaign, such as Healthcare Reform, down the country's throat during their first two years in office and then worried about re-election they tend to focus their efforts on pumping up the economy as much as possible during their second two years to make sure that they stay in office.

Will this theory hold in 2010?  I suspect that for the most part it will.  The S&P 500 is essentially flat YTD.  While I expect a lot of volatility along the way, I wouldn't be surprised if we ended the year basically flat as well.  It doesn't really matter to me what the general market does.  The majority of my portfolio is invested in either high yield bonds that I bought during the credit crisis or cheap, dividend-paying stocks many of which have specific catalysts that will help their stock prices in the future.  I have no problem holding onto these investments for several years.  

Even though I'm not all that concerned about the gyrations of the major indices, they are interesting to talk about and follow. 

Deej

4 Comments – Post Your Own

#1) On May 18, 2010 at 10:04 AM, ayekappy (< 20) wrote:

Since 1932. 

Also, Barrack had to START his term trying to make the economy grow and has been since.  It's not like he's going to try even harder this time around.

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#2) On May 18, 2010 at 10:14 AM, TMFDeej (99.29) wrote:

Very good points.  The economy certainly is going through a period that is unlike anything that the U.S. has seen since the 1930s.

You are also correct that President Obama had to throw the kitchen sink at the economy at the beginning of his term in order to stabilize the economy.

Who knows if this theory will hold true this time around.  Time will tell.  I'm certainly not putting any money behind this.

Much like much of the Technical Analysis mumbo jumbo, I personally think that many of these theories tend to become self-fulfilling prophesies as traders assume that they will happen and act accordingly. 

At least it's interesting to talk about. 

Deej 

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#3) On May 18, 2010 at 10:21 AM, JakilaTheHun (99.94) wrote:

New Presidents likely try to cram the promises that they made during their election campaign, such as Healthcare Reform, down the country's throat during their first two years in office and then worried about re-election they tend to focus their efforts on pumping up the economy as much as possible during their second two years to make sure that they stay in office.

Conversely, the healthcare reform included a number of stealth tax increases that are particularly relevant to investors.  There is normally a December/January effect in most years, with investors making moves because of capital gain tax considerations. However, this year could be exacerbated by the CG tax increases, coupled with the massive run-up since Mar '09. 

Are investors sitting on 100% - 500% gains willing to pay higher taxes to hold till 2011?  Probably not.  So I expect there will be a lot more movement than usual, with investors sitting on larger gains pulling out before the end of '10.   Those with loses might, conversely, wait till 2011 to sell out.  

I wouldn't think all of this would be a big deal if we hadn't experienced one of the hugest rallies in history after March '09.  Given that, it seems like there's a bigger chance that we weill see a sell off. 

 

Another consideration --- given globalization, Presidents may increasingly have less power to manipulate the economic cycles.  

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#4) On May 18, 2010 at 11:15 AM, NVTreasureHunter (29.10) wrote:

Just a note. you posted:

According to Mr. Grantham, there has not been a serious decline in the stock market during the third year of the Presidential cycle since 1932.

The link to the other article states:

Markets are worst performing in years one and two of the new term.

 

This IS the 2nd year of the new term, not the 3rd year, so 2009 and 2010 would be the worst performing years while 2011 and 2012 would be the better years.

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