Elections and Markets

With a month to go before Americans hit the polls, it’s time for the quadrennial exercise of predicting how elections will impact stock prices. Let’s start with a disclaimer: as a long-term investor, you should not make changes to your portfolio in an effort to outfox the tried and true investment strategy of identifying your personal goals and objectives; creating and sticking to a diversified asset allocation plan, which incorporates low cost index funds; and rebalancing two to four times a year. That’s why the following should come under the category of “fun with facts and figures,” rather than any prescriptive advice as to how to reallocate your portfolio. That said, there are going to be a lot of articles and news segments, not to mention political commercials discussing which candidate is better for your money, the markets and the economy. Let’s start with the “Presidential Election Cycle Theory”, which posits that regardless of whether Republican or Democrat becomes the leader of the free world, US stock markets are weakest in the year following the presidential election, improves in the second year, peaks in the third year and then is weak in the fourth year. The Presidential Election Cycle Theory has held up even better for two-term presidents.

But like almost every market theory (“The January Effect”, “Sell in May and Go Away”), there are always exceptions to the rules. While the theory played out through most of the twentieth century, it has been less reliable lately. In fact, the last four years has disproved the Election Cycle Theory. In the first year of President Obama’s second term, the Dow saw an impressive 27 percent return and then 7.5 percent in year two. Last year, which was supposed to be the strongest of the cycle, the blue chip index dropped by 2 percent. The Dow is up 5 percent through the first three quarters of the year.

How does the President’s party affect the stock market? Data show that since World War II, the average compound annual growth rate for stocks is 9.7 percent under Democratic Presidents and 6.7 percent under Republicans. The analysis can be carved up lots of different ways, depending on a split Congress and chances are you can find the combination that supports the way you want to vote.

But a recent academic study, “What to Expect When You’re Electing,” finds that “There is no systematic difference between Republicans and Democrats” when it comes to steering the direction of the stock market. What does matter is the direction of interest rates: the stock market tends do better when rates are going down than when they are rising. Given that the Fed is likely to restart its interest rate hike campaign, that could mean that whoever occupies the Oval Office will preside during a period when the stock market retreats.

Maybe we are looking at this backwards: According to InvesTech Research, the market may be a better indicator of the presidential election than visa versa. Generally speaking, if the stock market is up in the three months leading up to the election, the incumbent party usually wins. Losses over those three months tend to mean a new party will take control. In the 22 president elections since 1928, exceptions occurred in 1956, 1968 and 1980. In other words, the S&P 500 has an 86.4 percent success rate in forecasting the election.

I know you wanted a simple answer: Trump or Clinton, but in the end, isn’t it better to know that party affiliation has far less to do with your portfolio’s performance than bigger, macro economic trends? Instead of trying to outsmart the Mr. Market, my advice remains simple: address what is within your control, by creating a financial plan.

Employment Report: The Labor Department reported that the US economy added 156,000 jobs in September, slightly lower than expectations. The unemployment rate edged up from 4.92 percent in August (rounded down to 4.9) to 4.96 percent (rounded up to 5) in September, due to a 444,000 increase in the labor force. As a result, the participation rate climbed to a six-month high of 62.9 percent.

The broader unemployment rate (U-6), which includes people who want full-time jobs but can only get part-time jobs, remained at 9.7 percent. According to economist Joel Naroff, talking about broad unemployment “is meaningless.” The problem, he says, is that businesses have likely permanently shifted to hiring more part-timers than in the past, which makes comparing today’s U-6 rate with the pre-recession rate of about 8.3 percent, pointless. “People might want to work full-time, but if businesses don’t want full-timers, there is nothing workers can do. It is not the economy that has caused the rate to be high, but business hiring decisions.” 

MARKETS:

• DJIA: 18,240, down 0.4% on week, up 4.7% YTD
• S&P 500: 2164, down 0.7% on week, up 5.4% YTD
• NASDAQ: 5292, down 0.4% on week, up 5.7% YTD
• Russell 2000: 1236, down 1.2% on week, up 8.9% YTD
• 10-Year Treasury yield: 1.72% (from 1.62% week ago)
• British Pound/USD: 1.243 (from 1.2973 week ago) Trading in pound saw a dramatic, though short-lived 10 percent plunge fall on Friday, attributable to computer-based program trading.
• November Crude: $49.81, up 3.3% on week
• December Gold: $1,258.60, down 6% on week
• AAA Nat'l avg. for gallon of reg. gas: $2.26 (from $2.22 wk ago, $2.31 a year ago)

THE WEEK AHEAD: Quarterly corporate earnings begin this week - analysts expect a sixth consecutive year-over-year drop. The estimated earnings decline for the S&P 500 is -2.1 percent, led lower by energy and materials, according the FactSet. If the energy sector is excluded, the estimated earnings growth rate for the S&P 500 would improve to 1.3 percent from -2.1 percent.

Mon 10/10: Columbus Day Banks closed, stock markets open, bond market closed

Tues 10/11:

Alcoa

6:00 NFIB Small Business Optimism

Weds 10/12:

10:00 JOTS

2:00 FOMC Minutes

Thursday 10/13:

8:30 Import/Export Prices

Friday 10/14:

Citigroup, Wells Fargo

8:30 PPI

8:30 Retail Sales

12:30 Janet Yellen speaks