The next US presidential election will be held on November 5, 2024.
That’s exactly 79 weeks, a little over 18 months, from today.
As FMS readers know, I’m looking for the US economy to enter recession later this year, most likely by the third quarter. And, if history is any guide, that will be bad news for the stock market; accordingly, I’m looking for the S&P 500 to see lower lows.
One piece of push-back on this outlook I’ve received from a handful of readers regards the presidential cycle for stocks and the economy.
The idea is simple, and I must admit, logical.
Regardless of political party, or any illusions of altruism they may project, politicians are all about talking up their records, touting achievements, blaming failures on someone else and, most important of all, getting elected or re-elected to office.
So, it makes sense a US president might try to do a bit of window dressing in the lead-up to an election to burnish their reputation and convince voters they’re doing a standout job. The same can be said for a term-limited outgoing president who’s seeking to boost the fortunes of the next candidate from their own political party.
In his final statement in the October 28, 1980 debate with incumbent President Jimmy Carter, Ronald Reagan famously suggested voters ask a simple question to help with their decision: “Are you better off than you were four years ago?”
That simple question strikes at the heart of the matter. If voters have good jobs, the economy is growing and inflation is under control, the sitting president – or the president’s party – has a significant advantage in the election. In early November 1980, however, the US economy was in trouble with unemployment at 7.5% and inflation at a whopping 12.6%; Reagan defeated Carter to become the 40th President of the United States.
So, there’s every incentive for a sitting president to do anything in their power to promote a sense of economic well-being in the lead-up to election and talk up the stock market. That might include campaigning for an economic stimulus package to encourage growth, promising to pass economic stimulus if re-elected, or even trying to coerce or encourage the Federal Reserve to cut interest rates, or refrain from hiking rates, around the election.
As it applies to the current situation, this presidential cycle hypothesis holds President Biden won’t want the economy in recession 18 months from now. If the recession were to start in Q3 as I expect and last roughly 9 months – a mild and short-lived downturn – that has the economy only just exiting recession next summer, cutting it a little close for comfort for the 2024 election cycle.
There’s some logic to this argument, so let’s see if it holds water starting with the stock market:
Source: Bloomberg
I examined every presidential election cycle since Teddy Roosevelt’s successful re-election bid on November 8, 1904, and there have been a total of 30 elections since 1904.
I have data on the closing price of the S&P 500 back to December 30, 1927, and for the Dow Jones Industrials since January 5, 1900. I examined price-only (no dividends) returns for the S&P 500 (Industrials prior to 1927) for the 79 weeks prior to every election since 1904.
As you can see, the average 79 week return leading up to a presidential election is 12.2% and the average rolling 79-week return for the entire sample is 11.8%, so you could say that over the past 120 years, the stock market has tended to do about 0.4% better than average in the 79 weeks before presidential elections.
However, that’s such a tiny deviation from the mean, it’s just not statistically significant.
It’s also skewed by a handful of large pre-election returns in the distant past. If we only look at the data since 1960, the 79-week pre-election return drops to 9.6% compared to a rolling average of 13.1%. And since 2000, the return in the 79 weeks prior to a presidential election is a paltry 3.4%, well below the rolling average of 10.9%.
In other words, the history of market returns shows buying the stock market 79 weeks before the US presidential election – that would be at the market close today – tends to result in average to well below average returns. This presidential stock cycle has also fared far worse in more modern cycles than it did prior to about 1960.
And that brings me to this:
The Stock Market isn’t the Economy
Of course, the stock market and the economy are two different things.
Generally, the market leads the economy and the S&P 500 peaks months before the US economy enters recession and bottoms out before the US exits recession.
There’s also a well-established wealth effect where rising stock (and housing prices) tend to make consumers feel wealthier, encouraging spending and economic growth. Therefore, I’d argue if presidents used fiscal and monetary levers to manipulate the economy ahead of an election, it would show up in the stock market.
However, perhaps there really is a presidential cycle that’s not captured by stock market returns.
Here’s a long list of economic indicators, and how they acted ahead of the election for the last 18 cycles:
Source: Bloomberg
Again, in the final 18 months of a president’s term there’s little evidence to suggest effective window dressing ahead of the election. On average, the unemployment rate drops about 0.12% between May of the year prior to the election and the election month (November). The median decline is about 0.35% over the same period.
Yes, I suppose that indicates a strengthening labor market, however, it’s rather modest in absolute terms. Looking at the past 18 cycles, the unemployment rate has dropped more than 0.5% in the 18 months prior to the election 8 times, it’s risen by more than 0.5% 4 times and it’s near unchanged 6 times.
Since 2000 unemployment has fallen more than 0.5% three times, risen more than 0.5% twice and it’s near unchanged once.
Hardly a definitive record of economic manipulation there.
And there’s more.
On the election month, the average ISM Manufacturing PMI reading is 53.9 and the median is 54.3, which indicate economic expansion on election day. However, the average for all months since 1951 is over 53 and the median is 53.7; thus, economic conditions on this basis are indistinguishable from the long-term average.
The Fed Funds rate has risen in the 18 months prior to election day, but only by roughly 20 basis points on average and 40 basis points on the median. So, no “help” from the Fed there.
Inflation has fallen by 30 basis points on average and risen 30 basis points based on the median in the 18 months prior to the election, so little evident pre-election trend on that basis either.
Bottom line: The historical record suggests you shouldn’t hang your hat on a pre-election stock market rally or the US skirting recession over the next 18 months just because the Biden Administration would prefer the US economy to be healthy in November 2024.
Why Doesn’t It Work?
At the beginning of this issue, I wrote the presidential cycle theory seems logical or, at a minimum, plausible. However, I must confess I’m not surprised it has little support in the historical record.
In my experience people love to talk politics and it draws attention, readership and eyeballs. So, every election cycle we’re treated to an avalanche of articles and stories across the financial media about stocks to buy if the Republican wins and stocks to buy if the Democrat prevails at the polls.
However, these election themes have a checkered history. For example, do you remember back in January 2008 when Barack Obama told the San Francisco Chronicle “If somebody wants to build a coal-fired plant, they can. It’s just that it will bankrupt them.”
Some 11 months later, Obama won the election and was sworn into office on January 20, 2009; in his first two years as President, the Vaneck Coal ETF, which tracked the performance of coal mining stocks, soared 271.5%, besting the S&P 500’s 64.9% gain and the S&P 500 Energy Index’s 50.6% rally over an equivalent holding period.
Meanwhile solar giants First Solar and SunPower, supposed beneficiaries of an Obama win, managed a gain of 6.99% and a loss of 52.8% over equivalent holding periods respectively.
And don’t forget that the Democrats controlled both houses of Congress as well with a filibuster-proof supermajority in the Senate when Obama was sworn in as president.
Then, Donald Trump’s win in 2016 was supposed to be good for oil companies and bad for alternative energy, right?
Only one little problem with that theory: The SPDR Oil & Gas ETF (NYSE: XOP) fell 21.7% in the first two years of his term, while First Solar soared 38% and electric carmaker Tesla was up 23.5%.
And Republicans controlled both houses of Congress as well at the start of President Trump’s first term.
I believe there are multiple reasons investing based on politics and government policy often doesn’t work out according to plan.
For one thing, it’s often said the President of the United States holds more power than any other person in world and maybe that’s true but there are forces more powerful than the president and more powerful than the entire US government – the market and economy.
Yes, there’s no doubt the President with a bit of help from Congress can manipulate the economy and markets in the short run. A great example is the epic fiscal and monetary expansion under Presidents Trump and Biden aimed at addressing the COVID lockdown recession of 2020. The economy boomed, it was the shortest recession in history, the fastest recovery from bear market lows to new highs in the S&P 500 on record and unemployment sank to the lowest levels since the late 1960s.
The stock market soared almost 50% in 2021.
However, there was a hangover in the form of massive price inflation and a bubble in several corners of the market. Ultimately that forced the Federal Reserve to attempt to rapidly undo all the stimulus they’d created; meanwhile, record-setting fiscal expansion in peacetime through 2020-21 has hampered the Fed’s efforts to cool the economy.
My point is that government actions to address a problem — real or imaginary — often have unintended and potentially damaging side-effects. Extreme policy moves, such as those in 2020-21, can often lead to even more damaging fallout. And when market forces build enough momentum, the problems will snowball regardless of who is sitting in the Oval Office.
Moreover, I believe the presidential cycle theory gives politicians in Washington DC too much credit.
After all, we know that monetary and fiscal policy, as well as new regulations and policy initiatives, all act on the economy with a lag. Those lags are unpredictable and variable.
A new bank regulation enacted today, for example, might not have an immediate impact on the financial industry and credit creation, but the effects could build over time and create a headache for the next administration.
Fed research suggests a 25-basis point rate hike takes 9 to 12 months to impact the economy, so what we’re seeing in the labor market today, for example, largely reflects what the Fed did last summer, some 250 basis points of hikes ago. And those lags are variable and change from cycle to cycle.
So, do you really think the presidential administration is capable of timing policy moves to impact the economy just in time for the election while staving off any unwanted side effects until long after results are in?
And do you think the President, or his advisors and political allies, even know and understand the full effects and side effects of a given policy or piece of legislation?
I certainly don’t.
Indeed, if the president were trying to time things just right to win elections, the Carter Administration was unsuccessful in 1979-80, the George H.W. Bush Administration was unsuccessful in 1991-92 as was George W. Bush in 2007-08.
Put yourself, for just a moment, in the current administration’s shoes right now. Assuming you want to win the 2024 election, do you think it’s more important to push to bring inflation down – and risk a recession with at least a modest rise in unemployment – or let the good times roll and risk $6.00/gallon gas prices in November 2024?
Whichever you choose, how would you go about achieving that goal, especially with a divided Congress?
History suggests governments struggle to restrain prices once the proverbial inflation genie is out of the bottle.
And, do you really think millions of traders all over the world sitting in front of their Bloomberg terminals at 7 AM after guzzling 11 cups of coffee are going to fail to notice the manipulation and react accordingly?
I don’t and history suggests pre-election politics don’t drive markets or the economy.
DISCLAIMER: This article is not investment advice and represents the opinions of its author, Elliott Gue. The Free Market Speculator is NOT a securities broker/dealer or an investment advisor. You are responsible for your own investment decisions. All information contained in our newsletters and posts should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision.
I wouldn't take the presidental cycle seriously on my own, but Geremy Grantham, who is besides that an "ultra bear", a few months ago gave a significant probabilty to a scenario, that in the current year, presidental cycle messes up with the continuation of the bear market, especially that it may interrupt it /delay it/ postone it. From the GMO's article it was obvious, that he deems presidental cycle a seriuos and underestimated factor of market returns. What do you think?