Current presidential term not in line with the cycle

By DAVID MOON, Moon Capital Management, LLC
June 10, 2012

Other than religion and the long running Ginger-vs-Mary Ann debate, few things evoke as much disagreement as politics. When you add money, the debate can get emotionally ugly.

But there is one political point on which most everyone agrees: elected officials generally want to be reelected. They will suspend significant logic and dispense significant money in an attempt to cause that to happen.

Because of this, the really, really smart folks at the global investment management firm Grantham Mayo Van Otterloo have observed something they call the Presidential Cycle in the stock market.

In simple terms it says that the third year of a president’s first term in office is statistically the best year for stocks. The third year of second terms is also an abnormally positive year for stocks.

The worst returns in a president’s term of office tend to occur in the first and second years. This is when presidents do the least popular things, like increase taxes, hoping voters will forget by the next election.

By year three, things reverse. The Fed tends to drive interest rates lower. The federal government spends more money on pork projects, if that is possible. The result is that the stock market, in anticipation of presumed positive economic outcomes from these actions, tends to compact much of its four-year return into that third year of a president's term.

Actual GDP and consumer spending are generally lower in third years, compared to the four years as a whole. But in the fourth year of presidential terms, GDP growth is 0.60 percent higher than the four-year average; consumer expenditures are 0.50 percent higher.

That's some difference, but not much. The stock price effect in year three is much greater.

In the third year of a president’s term, the S&P 500 outperforms the average four-year return by 17.6. This doesn't mean that the average return every third year is 17.6 percent. It means that, compared to the average stock return during a president's four-year term in office, the third year tends to be 17.6 percent higher than the arithmetic mean of the four.

The current presidential term of office has been a unique anomaly. Because of the condition of the economy when President Obama took office, his administration, along with the Federal Reserve Board, pursued typical third-year stimulative efforts in years one and two.

This early stimulus, combined with a correction of the natural market overreaction of the 2008 bear market, set the stage for a 40 percent S&P 500 increase in President Obama’s first two years. Based on those figures, the Presidential Cycle would have suggested a return of more than 30 percent in 2011, instead of the actual return of about zero percent.

What is the market likely to do the remainder of 2012? The S&P 500 has increased about four percent through the first 24 weeks of the year, The Presidential Cycle suggests a pretty flat market for the remaining six months.

But the past three years haven’t fit neatly into very many models, including the Presidential Cycle.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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