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. Last Updated: 07/27/2016

Election Theory Says Lay Low in '97

WASHINGTON -- The effect of individual political events on the market is unpredictable and usually ephemeral. But step back a little and you'll find that U.S. elections do have a remarkably powerful impact on stocks -- and a predictable one.

For the past 30 years, Yale Hirsch, who publishes the "Stock Trader's Almanac," has been tracking the long-term effect of seasonality and other factors that financial experts call "exogenous" -- in other words, events that are independent of the market.

For example, Hirsch and others have identified "The January Barometer" -- as the first month of the year goes, so go the next 11 -- and the "Decennial Cycle" -- years ending in 5 and 8 are great for stocks.

Much of what Hirsch has found is entertaining but of questionable value to sensible, long-term investors. Correlation is not the same as causation.

But Hirsch's research on elections has produced results that are so striking you'd be foolish to ignore them. In particular, he has found a clear four-year pattern linking the presidential election cycle to the stock market.

In the year before a presidential vote (1975 for instance) and in the election year itself (1976), the stock market rises sharply. But in the year after the election (1977) and in the mid-term year (1978), the market is sluggish -- far below average.

Hirsch looked at this pattern in the 41 elections since 1832 and found that in pre-election and election years, the average gain in the Standard & Poor's 500-Stock Index, and its earlier equivalents, was 6.8 percent. But in post-election and mid-term years, the gain was a mere 1.0 percent -- figures exclude dividends.

More recently, for the eight presidential elections since 1964, the gain in the S&P averaged 17 percent in pre-election years, 14 percent in election years, 2 percent in post-election years and minus-2 percent in mid-term years.

In only one of the 16 election and pre-election years did the S&P decline, but it suffered losses in nine of the 16 post-election and mid-term years!

The elections-market connection isn't coincidental. Preceding a vote, politicians baby the economy, postponing the dirty work until after the balloting. "Wars, recessions and bear markets tend to start or occur in the first half of the term," writes Hirsch. Think of World War I (1917), the Crash (1929) and World War II (1941).

Does the market care which party actually wins the election? "Since 1900," Hirsch writes, "the market has shown an obvious preference for Republican presidents." On the day after the vote, it has risen on 10 of the 13 occasions a Republican has won, but on only three of the 11 times a Democrat has won.

In the month following an election, the market rose an average of 2.5 percent on Republican victories and fell an average of 1.8 percent on Democratic victories.

It's not hard to understand why Wall Street likes Republican presidents: lower taxes, less regulation, less federal spending and a more accommodating attitude toward investors.

But beware of oversimplifying the party dichotomy. The stock market is a forward-looking institution and if investors anticipate the election of a president who will be good for stocks, they'll bid up prices before the vote. In fact, after the election, prices might fall since the good news has already happened and thus no longer lies ahead.

With Bill Clinton, the pattern is somewhat murky. The market moved up slowly in the fall of 1992 as it became clearer that he would unseat George Bush. The rise in the S&P from September through December was about 5 percent. It might have been higher -- after all, 1992 was a recovery year after the 1990-91 recession -- if Bush were re-elected.

Also, Clinton was seen as a centrist Democrat, promising a tax cut and a balanced budget.

His early presidential performance, such as tax increases and the defeated health care plan, may have unsettled investors. From November 1992 to November 1994, the S&P rose at an annualized rate of just 6.6 percent.

Then, right after Republicans took control of Congress, the market started to soar. From November 1994 until December 1995, the S&P rose at an annualized rate of 28.8 percent.

Since the Republican Party's attempts to balance the budget and cut taxes were thwarted in early 1996, the S&P has risen 4.9 percent. At that pace, the annual gain will be 7.5 percent -- anemic but better than during Clinton's first two years.

Of course, the market's performance may have nothing at all to do with Bill Clinton and the Republicans. It could be related to Hirsch's election cycles. Then again, politics may play no role at all. Federal Reserve policy or even corporate profits (gasp!) could be moving stocks.

In the end, the best way to invest is to analyze companies, not presidential races. Still, I can't help being intrigued by Hirsch's election-year cycles. If he's right, 1997 would be an excellent year to take a breather from stocks.