The publication date of this article is election day in the United States. By the time you read this we may know the outcome of another bizarre election. Much will be written about how the outcome will impact our investments, yet in reality it will have surprisingly little impact, and not in any predictable way.
The Presidential Cycle postulates that the market underperforms in the first two years of an administration and overperforms during the second half of the term. The theoretical reason is that a new president works feverishly on his election agenda early in the term, creating extra uncertainty and pushing items perceived as economic or market unfriendly. Then attention turns to stimulative activities in the second half, attempting to boost economic activity, improving the probability of re-election.
Let’s look at the actual total annual returns for the S&P 500 from 1925 to 2020 to date. There were 24 Presidential Cycles. For the purpose of this exercise, I calculated simple numerical averages rather than compound growth rates. During the inauguration or first year of a term, the average annual return was 10.5 per cent with a range from -35.0 to +54.0 per cent. During the second year, the average was 8.6 per cent with a range of -26.5 to +52.6 per cent. During the third year, the average performance was a gain of 18.5 per cent with a range of -43.3 to +47.7 per cent. During the last year of the term, which we are currently in, the average was 11.0 per cent with a range from -37.0 to + 43.6 per cent.
The third year of the cycle has experienced appreciably better returns than any of the other three years, which have all been similar. However, even the third year exhibited a similar range of outcomes. Therefore, I would suggest that while there is a small amount of merit to the Presidential Cycle theory, it doesn’t help time investments. Would it be wise to sit out the fourth, first and second year, with average returns of about ten per cent, just because the third year is best?
Most business people and investors generally prefer Republican administrations, but which party is actually best for the markets? It might surprise you that over the last 96 years, markets have performed better with the Dems in charge. The 24 Presidential Cycles were evenly split with 12 Republican and 12 Democratic administrations. The average return for the Dems was 14.9 per cent versus 9.4 per cent for the Republicans. The worst periods were under Republicans George W. Bush from 2001 to 2008 and Herbert Hoover from 1929 to 1932. Markets under Donald Trump were doing well until COVID hit and he still carries an above-average return. However, returns have been slightly less than during either of Obama’s terms, which probably irks him immensely.
There are better and worse presidents of both stripes and I would not make investment decisions based on who’s in the White House.
A common market timing saying to “Sell in May and go away,” is particularly cringeworthy. The saying reflects that historical market performance is best in the November to April period, but that doesn’t make returns negative from May to October. The only long-term negative month is September. Should we sit out five positive months to avoid one negative one? Should we sell everything in August to avoid September’s average return of -0.5 per cent, then buy everything back in October?
There are a couple of other portfolio-churning activities regularly promoted that I avoid. The first is to set a target when you buy a stock and sell as soon as the target is reached, but what guarantee do you have the replacement stock will do better? Once you find a winner, it is usually best to stick with it. Stop-loss selling sounds like a smart concept, to sell any stock that depreciates ten per cent from where you buy it, or from any recent peak. The idea is to prevent large losses, but the practice will also prevent large gains. Declines can be rapid and attempts to sell at a 10 per cent loss might only be transacted after a much larger loss.
The genesis of many of these bad ideas goes back to the days when stockbrokers, rather than the client, made money on stock-churning activities. Research from the mutual fund industry suggests portfolios with the lowest turnover generally have the best performance.
While many sayings or old wives’ tales are bunk, one with merit is, “It’s time in the market, rather than timing the market, that builds wealth.”