Topic: How To Invest

How do stock markets and presidential elections react to one another?

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The stock market and presidential elections have a relationship that can be summed up by what is known as the “four year rule.”

The stock market and presidential elections’ “four-year rule” says that U.S. Presidents tend to get a lot friendlier toward business and investors in the second half of each four-year U.S. Presidential term. Stocks usually (but not always) rise in response.

The switch to investor-friendliness often occurs within a few weeks of the mid-term Congressional election (the last one was in 2014).

Presidents naturally want to win election for themselves, or their preferred successor. They also want to bolster the prospects of their political party. To do that, they have to win favour with voters. It’s especially crucial for them to charm investors into buying stocks in the second half of the Presidential term. That’s the main reason you see the stock market and presidential elections react to one another.

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Stocks have been going up in the Obama years since at least 2009. The President can help sustain that trend and bolster investor confidence by halting or at least cutting down on policies like raising taxes and running high deficits and expanding government regulations.

When Mr. Obama’s approval rating plunged to record lows, other Democrats, right up to Hillary Clinton, distanced themselves from the President and his policies. So investors may have seen these troubling policies as a passing phase, rather than a lasting change in the U.S. business environment. This contributed to the ongoing strength in U.S. stocks.

Another key reason for the Obama bull market is that stock prices may have just gone down too far in the 2008/2009 market slump. Since then, overall prices have been rebounding—“regressing to the mean”, as an academic would put it.

When you look at how the market has performed since any record-setting plunge, it always looks as if it has gone too high in too little time. The Toronto exchange index has nearly doubled since March 2009. That is an unusually fast rise. But go back a little further, to summer 2008, and the market has barely budged.

It hit a peak in mid-2008, went through a heart-stopping plunge until March 2009, then rose.

The 10-year picture provides a more balanced perspective. In the past decade, the Toronto stock market has had an average annual compound gain of around 2.7%, not counting dividends. That’s a low return, although higher than today’s low bond yields. But it’s well below the long-term average yearly compound gain of 8% to 10%.

The market may make up for that below-average decade by putting on an above-average performance in the next five to 10 years.

The pessimistic view is getting stale

Pessimists keep focusing on how much the market has gone up since March 2009. They keep repeating that stock prices have only gone up because interest rates are too low. They take it for granted that interest rates are sure to go way up again one day, and that stocks will respond with a plunge.

That interest-rate surge/stock-price plunge mantra has been around since 2010. It’s a neat, tidy prediction and it makes common sense. But neat, tidy, common-sense predictions rarely come true in the stock market, least of all on a widely shared timetable.

Demographic trends could put downward pressure on interest rates for years to come. Interest rates were high in the 1970s and 1980s in part because baby boomers were borrowing heavily to buy and furnish their first family home, educate their children and so on. Now they no longer need to borrow to pursue these goals.

Seeing how the stock market and presidential elections have reacted to one another in the past, and the current market rise that has been going on since 2009, it’s not out of the question to see this market trend continue. I still think we are in a secular bull market—a long-term rising trend that will last a lot longer, and take prices a lot higher, than most people expect. If so, the rise could go on for a long time.

Do you or your investment club use the four year rule to make strategic market moves ? Have you noticed any other market patterns mimic the four year rule? Share your experience with us in the comments..


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