A month ago I explained how the three months leading into a U.S. Presidential election featuring an incumbent tend to represent a bullish period (see "The Positive Trade When Incumbent Presidents Run For Re-Election"). While I provided the graphs showing the tempting upside opportunities on the S&P 500 (SPY), I neglected to include the risk of drawdowns. It turns out that this bullish period also features very mild sell-offs, especially relative to the typical turbulence the stock market faces between the ends of July and October.
Since 1950, the average annual return from the last trading day in July to the last trading day in October (this is a refinement of my earlier labeling) is extremely small compared to the overall risk taken during this time period:
Annual Performance of the S&P 500 From July End to October End Since 1950 (including maximum drawdown or loss)
- average gain: 0.09%
- median gain: 0.20%
- average drawdown: -6.37%
- median drawdown: -4.29%
(click to enlarge)
Annual Performance of the S&P 500 From July End to October End Since 1950 (including maximum loss)
Pretty awful performance and very poor risk/reward ratios. Things improve when filtering down to election years - especially at the median - but the overall risk/reward is still unattractive.
Annual Performance of the S&P 500 From July End to October End During Election Years
- average gain: 0.11%
- median gain: 2.02%
- average drawdown: -5.60%
- median drawdown: -3.49%
(click to enlarge)
Annual Performance of the S&P 500 From July End to October End During Election Years
While the risk/reward for starting a bullish trade at the end of July is not good, a trader could make a good argument for buying on any 5% decline during this pre-election period. Such a purchase should generally result in an attractive return by the end of October as the market tends to recover in time for the election festivities.
Once we filter down to elections that feature a running incumbent, the trading proposition vastly improves. In fact, a 5% decline now looks like a downright gift. Note that in two of the nine featured years, the S&P 500 never looked back after July ended (1984 and 1996).
Annual Performance of the S&P 500 From July End to October End During Election Years With A Running Incumbent
- average gain: 2.69%
- median gain: 2.59%
- average drawdown: -2.78%
- median drawdown: -2.24%
(click to enlarge)
Annual Performance of the S&P 500 From July End to October End During Election Years With A Running Incumbent
Source: Dates for elections from Wikipedia, prices from Yahoo!Finance
Of course, these data do not say that election status is the only determining factor for stock prices between the end of July and October. They do suggest that at a minimum, for this election year featuring a running incumbent, it is not wise to bet too aggressively from the bearish side during this period and that the better risk/reward strategy is likely to buy the dips.
With these conclusions in mind, I am planning to close out my latest bearish trades on the S&P 500 as the current pullback plays itself out. I am anticipating a mild extension to the current pullback as the market continues its drop out of overbought territory. After this cycle is complete, I will focus on making this pre-election trade work.
Be careful out there!
Disclosure: I am long SDS.
Additional disclosure: Also long SSO puts.
