The Secret Stock Market Pattern in Presidential Election Years

The second half of presidential election years is a different story, with the stock market stronger than in nonelection years, on average. The Dow’s second-half return in presidential election years averages 8.6%, versus 3.0% in all other years. The net full-year result is that there is virtually no performance difference between presidential and nonpresidential years.

This midyear reversal may be the key to explaining why relatively few investors are aware of this pattern. By focusing on full-year results, you’d never know that the market tends to be relatively weak in the first half of presidential election years and relatively strong in the second half. I was made aware of the pattern by Cam Hui of the Humble Student of the Markets blog. Because of the pattern, he says that “chances are that equity returns will be flat to choppy in the first few months [of 2024] and the majority of the gains will be seen in the latter part of the year.”

Why would the first half of election years be weak?

You should never bet on a seasonal pattern, no matter how strong its statistical basis, unless there is a good theoretical reason for why it should exist in the first place. One possible explanation for this presidential election year pattern is that the stock market performs poorly early in such years in reaction to the economic uncertainty created by the competing candidates’ policies. The market recovers later in such years as this uncertainty reduces, either on Election Day or earlier, if a clear front-runner has emerged.

To test this hypothesis, I turned to the Economic Policy Uncertainty (EPU) index created several years ago by finance professors Scott Baker of Northwestern University, Nick Bloom of Stanford University, and Steven Davis of the University of Chicago. The index, for which historical data extends back to 1900, “quantifies newspaper coverage of policy-related economic uncertainty,” according to the professors’ website. I wondered if the EPU is higher than average in the first half of the year and lower than average later in the year.

The EPU largely adheres to this pattern, as you can see in the chart below. It plots the ratio of the EPU’s average level in a given month of the presidential election year to its average in the corresponding month of the other three years. This ratio rises fairly steadily in the first six months of the calendar and then declines through September. 

The correlation between the EPU and the stock market isn’t perfect. The ratio jumps in September and October before falling back in December. But for those two months, the EPU provides at least some theoretical support for early-year stock market weakness in presidential election years and latter-year strength.

Will the future be like the past?

Even if the EPU provided unequivocal support for the presidential election year pattern, there still would be no guarantee that 2024 would live up to it. That’s because this year could easily diverge from the historical pattern, Terry Marsh of the University of California, Berkeley, said in an interview. Marsh is co-author, with Kam Fong Chan of the University of Western Australia, of a study several years ago into the relationship between the EPU and the stock market in midterm election years.

One reason to wonder whether this year will be unique is that it’s hard to envision economic policy uncertainty receding much after midyear. Indeed, given the not-unlikely battles over vote totals and endless recounts, uncertainty could grow after the election rather than decline. That would create stiff headwinds for the stock market, of course.

Another factor that Marsh mentioned is the evolving role of the Federal Reserve. It plays a much more dominant role today than it did in prior decades, especially as the stock market is concerned. That makes it even harder than it already would be to extrapolate the past into the future.

Qualifications aside, the existence of this historical pattern suggests we should be prepared for the possibility of a weak stock market in the coming months. As of mid-January, the Dow Industrials are sitting on more than a 1% loss. That compares to an average full-month gain of 0.9% for all Januarys since the Dow was created in the 1890s.

Expecting weakness for the first half of the year doesn’t have to mean turning bearish on the stock market’s major trend. But, as Hui reminds the bulls, “Trees [don’t] grow to the skies and prices don’t rise in a straight line.”

Mark Hulbert is a regular contributor to Barron’s. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.

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2024-01-18 07:00:00