In previous articles I explained why I'm very cautious regarding the stock market (SPY) (VXX) (IVE) (SH) (VOO) (SSO) (SDS) (IVV) (SPXU) (UPRO) (QQQ) (DIA) (DOG) (UDOW) (SDOW) (DDM) (UDPIX) (UWPIX) (UDPSX). I warned about corporate profits that have been declining over 5 consecutive quarters. I shared my concerns over the historically expensive valuations and over the flawed attempts to justify them. I also shared my view that Central Banks are artificially inflating asset prices and that investors behavior is similar to the one we saw in past bubbles.
Today, I'll look deeper into an argument that is very dear to the bulls: the fact that we're in an election year.
The stock market performs well in election years
Let's start with the good news: the stock market usually performs well in election years. In fact, since 1928 we only saw 4 negative election years in a total of 22, or less than 20% of the time. Also, looking into these 4 negative election years it is easy to understand that there were strong reasons for the decline: the great depression in 1932, the second world war in 1940, the dotcom bubble in 2000 and the subprime crisis in 2008.
Source: Summer Hilffs
This is the general view. However, like in many other situations the devil is in the details.
The pre-election year is the best of the Presidential cycle
The first critic to be made is that all years of the presidential cycle show a positive performance. That comes as no surprise because in the long-term the stock market trend is up.
Source: Stock Trader's Almanac, US Global Investors
The way I see it, the presidential cycle should be used as an indicator of over or underperformance but not as an indicator of absolute performance. In fact, it is undeniable that the pre-election year is historically the best performer of the cycle while the post-election year is the worst performing year.
The 4th year of the second mandate is a bad year for stocks
Since 1900, election years gain on average 7.5% and show a positive performance 71% of the time. That's better than the 7.0% average gain and above the 66% positive years since 2000 for all years.
However, after the second world war, things got a bit worse. In fact, since 1945, election years gain on average 6.1% and show a positive performance 71% of the time. That's worse than the 8.7% average gain but still above the 66% positive years since 2000 for all years.
Source: S&P Capital IQ
But the most disturbing signal comes when we disaggregate the performance between first and second term mandates. In fact, both since 1900 and since 1944, the 4th year of the second term is on average a negative year for stocks and is down 56% of the time. Needless to say, we're currently at the end of Obama second mandate.
The S&P500 is up over 6% year to date
Another relevant point is that the S&P500 is already over 6% up year to date. This leaves a very small upside until year end given the average 7.5% election year gain since 1900 and no upside until year end given the average 6.1% election year gain since 1944.
If we use the second term statistics instead of the overall ones, then the S&P500 has room to fall over 7% until the end of the year as the average return since 1900 is -1.2% and since 1944 is -1.4%.
October is a bad month in election years
It is interesting to note that in election years, the "sell in May and go away" doesn't really work. In fact, the summer months from June to August are the best performing months of the year. On the opposite side April and May are the worst months of the election year.
Source: Thomson Reuters, Bloomberg, UBS, US Global Investor
Regarding the outlook for the last part of 2016, if history is a guide, September (still running) and October should be negative months for stocks.
Election years performance is better when Republicans win
The last statistic I would like to bring to the table concerns the party who wins the election. Even though the stock market gains on average 7.0% in election years, if Democrats win the election gains are only 3.33% whereas if Republicans win stocks gain 11.40%.
Source: Market Oracle
Clinton and Trump are virtually tied in many polls. Still, Hillary seems to be the favorite to win the election and is slightly ahead in most of the polls. In case of a democrat win, using history as a guide, stock gains should retreat from the current 6.2% to the average 3.33% by year end.
The bull argument that election years are good for stocks has some flaws.
Given that stocks are already up over 6% year to date when on average they gain 7% in election years, given that stocks fall on average 1% in the 4th year of the second mandate, given that October is usually a negative month in election years, and given that the market is trading close to 2016 highs, isn't this a good time to take profits? I think so.
Also, we all know what comes after the election year. Yes, that's right: the post election year :) which is the worst performing year of the Presidential cycle. After an 8 year bull market (already the second longest and the fourth most powerful in history), I'm a bit worried about what's next for stocks. The dotcom bubble cracked at the end of Bill Clinton second mandate and the subprime crisis collapsed at the end of George Bush second mandate. Will the FED Bubble deflate before Obama leaves office?
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.