It’s impossible to predict the markets, but historical data enables us to glean potential trends. The 4-year Presidential Cycle and its connection to Stock Market returns is one such example.
While this theory shouldn’t control your investment planning, it can offer insight and help investors make informed decisions. In this article, we’ll cover the basics of this theory, its limitations, and how to integrate it into your investment portfolio.
Key Takeaways
- The Presidential Election Cycle Theory describes stock market performance patterns during an election cycle.
- This theory is based on patterns in historical data.
- While many studies confirm the theory, the interpretation and application of the theory are debated.
- In applying this trend to your own investment decisions, you need to understand the reasons behind the trend in each Presidential term.
What is the Presidential Cycle Stock Market Theory?
The presidential election cycle theory seeks to explain a predictable pattern of stock market performance during each transition of power. Developed by Yale Hirsch, this theory hinges on a basic pattern that has been observed over several presidential administrations from the mid-1960s to the early 2000s:
- Weak performance in the first two years of a president's term
- Spike and peak in the president's third year
- A fall off in the president's fourth year
This cycle begins at the start of each presidential term, supported by decades of historical data. If true, this theory suggests that the first two years of a president’s term will always coincide with the weakest stock performance.
That said, this theory isn’t set in stone. Market analysts continue to debate over its validity, with opponents arguing that the data doesn’t support the theory.
What Proponents Say in Favor of the Theory
It is essential to recognize that the trend appears to apply when examining averages broadly, but does not seem to hold true when considering specific presidential administrations. For example, a study entitled “Mapping the Presidential Election Cycle in the US Stock Markets,” published in 2003, documented a broad cycle in the S&P 500 over the years from 1965 through 2003.
Over this period, the researchers calculated the average return for all first years of presidential administrations, then for all second years, and so on, for third and fourth years.
A bit confusing? Here’s what this looks like:
| Year | Cycle Year |
|---|---|
| 1965 | 1st Year |
| 1966 | 2nd Year |
| 1967 | 3rd Year |
| 1968 | 4th Year |
| 1969 | 1st Year |
| 1970 | 2nd Year |
| 1971 | 3rd Year |
| 1972 | 4th Year |
- The average of the first years would be the average of returns in 1965 & 1969
- The average of the second years would be the average of returns in 1966 & 1970
- The average of the third years would be the average of returns in 1967 & 1971
- The average of the fourth years would be the average of returns in 1968 & 1972
Of course, the authors calculated averages for all the first years, all the second years, and so on, and by doing this, they documented the broad pattern.
- Average return for every year 1 in the study was 6.58%
- Average return for every year 2 in the study was 4.35%
- Average return for every year 3 in the study was 13.5%
- Average return for every year 4 in the study was 6.58%
It certainly appears that over the period from 1966 through 2003, “on average,” the third year of the presidential term overlapped with the strongest average market gains.
According to other supporters of the theory, the cycle can be observed in both large-cap and small-cap stock returns in the US. What appears most amazing is that supporters claim the cycle prevails regardless of whether the president is an incumbent or not. Supporters also claim that the pattern doesn’t appear to be driven just by returns over a few periods. They steadfastly believe the pattern is very consistent.
Limitations and Criticisms of the Presidential Cycle Theory
Skeptics, on the other hand, would point to the relatively small number of years in the studies of this presumed cycle. They can also point to some significant departures from the theory fairly easily.
It may be one thing to say that the average third presidential year will be better than the average first & second years, but that does not mean every presidential third year will be better than that president’s first & second years.
This is especially true when you look at a broader index than just the S&P 500. For example, if we look at a broad measure of all stocks from 1981 through 1992, the pattern seems to disappear, as shown below:
| Year | Cycle Year | Return |
|---|---|---|
| 1981 | 1st Year | -1.73% |
| 1982 | 2nd Year | +15.4% |
| 1983 | 3rd Year | +24.3% |
| 1984 | 4th Year | +4.1% |
| 1985 | 1st Year | +35.1% |
| 1986 | 2nd Year | +28.7% |
| 1987 | 3rd Year | +6.4% |
| 1988 | 4th Year | +21.9% |
| 1989 | 1st Year | +25.1% |
| 1990 | 2nd Year | -11.1% |
| 1991 | 3rd Year | +30.8% |
| 1992 | 4th Year | +6.9% |
We’ve color-coded the strong years in each of these presidential terms to demonstrate the point that the pattern breaks down when you consider a different time range and a broader measure of stock performance.
Even in those years when a third year was a president’s strongest year, that did not necessarily mean that the president’s second year or their first year were bad years.
We believe the pattern is more of an anomaly than a real trend, based on the relatively small number of election cycles examined in each of the academic studies conducted. It hasn’t been consistent from one presidential stock market cycle to the next, and it is certainly not a reliable predictor.
Market analysts skeptical of the theory believe that it rests on an assumption made by the various researchers, which overestimated presidential power. As all researchers know, it is very easy to look for evidence that supports your theory and thus prove your hypothesis by cherry-picking the data.
Whatever slight pattern might exist can easily be explained by causes that are much more significant to investment decisions than simply examining the year of a president’s administration.
One old political pro was asked why his candidate was winning the election. He responded, “It’s the economy, stupid.” There is a great deal of truth to that. Americans tend to vote based on kitchen-table issues, and one of the most important is whether the economy is doing well. Given the lead time it takes for a new administration’s policies to take effect, it’s not surprising that a president with a bad economy in their fourth year would be replaced by a new president, whose first year might still bear the consequences of the outgoing president.
It might take a year or so for the new president’s policies, if they are better, to have an effect. Likewise, many administrations tend to lose steam and enthusiasm in their fourth years, and during these times, it’s easy for bad policies or lapses to creep in.
What this means is that administrative economic policies affect the economy, which in turn impacts and drives the overall stock market. Investors would be better off looking at the underlying economic policies being enacted than simply counting the years in a president’s term.
Moreover, it is also possible that a cycle like this would be driven by investor sentiment rather than by actual economics. Stock prices in the long term reflect the overall health of the economy. In the short term, they can often simply reflect whether individual investors are irrationally exuberant or irrationally fearful. Regardless of the reason, basing investment decisions on human emotions is not sustainable and will likely lead to substantial long-term failure.
Practical Applications and Implications
Why does this matter? Understanding this basic theory and the reasons why it fails over the long term can help investors make more informed decisions about their investments, especially during periods of significant policy changes, such as Trump’s 2025 tax policy plans.
Investment decisions should be made based on real assessments of tax, regulatory, and other macroeconomic data. You need to consider what a new administration intends to do, what they can accomplish given the Congress they have, the extent of those changes, and whether those changes are objectively beneficial or detrimental to the economy. The markets will reflect those realities, not the year count of any administration.
Taking Your Portfolio to the Next Level
The 4 Year Presidential Cycle Theory gets a lot of media buzz, but it is not a way to structure your portfolio. If you truly want to take your portfolio to the next level, where an objective and predictable approach can help you achieve real long-term results, then you’ll jettison all the urban-legend theories and conduct a professional review of your portfolio with an experienced and 100% objective wealth advisor.
The right wealth management firm can help you grow and preserve your assets with in-depth and tailored portfolio management. The right wealth management firm will offer a steady hand, not an emotional pitch. A reputable wealth management firm will possess experience and a fiduciary duty.
If you are ready for a second opinion, book a call with our objective, fiduciary advisors today.
Greg Welborn is a Principal at First Financial Consulting. He has more than 35 years’ experience in providing 100% objective advice, always focusing on the client’s best interests.
Greg Welborn is a Principal at First Financial Consulting. He has more than 35 years’ experience in providing 100% objective advice, always focusing on the client’s best interests.
