Presidential Election Could Buoy the Market

It's well documented that the stock market performs differently during the first two years of the election cycle and the final two years. Google is full of references to support this. It is clear that the market has generally become stronger as the election approaches, but there are too few data points (25 in 100 years) to provide statistically valid evidence.

Since 1872, the third year after a presidential election has posted the highest average return (9.1%) of any year in the cycle. The election year has averaged 5.9%, versus 3% for the first year of a cycle and 4.5% for the second year. The results have been less dramatic since 1982. The third year has yielded an impressive average of 15.8%, but the 2008 crash pushed the election year's average down to just 3.4%.

Nevertheless, it's difficult to ignore the fact that the market has risen more often than not since 1982 in the last two years of the cycle (violet sections of the chart below). For that practice to keep up, 2012 would have to do very well, because the market was unchanged in 2011.

The chart below shows the 30-day average of Obama's popularity with potential voters according to the Rasmussen daily poll. The chart is based on the net difference between the number of voters who strongly approve of Obama and those who strongly disapprove.

The correlation between the S&P 500 and Obama's popularity has been 62% since November 2010. In other words, when the market is advancing, there is a 62% chance that Obama's popularity is increasing, according to the Rasmussen poll. To think that the Obama administration is unaware of this correlation is to believe in fairy tales, so it is clear to me that officials will do what they can to support the market between now and November.

Voters tend to attribute a good economy to the administration in power, whether or not there is a correlation. So if we believe that incumbent presidents and their parties prefer the market to be strong leading up to an election, what can they do to help the market advance?

One method is simply jawboning -- just telling us every day that things are good and getting better. However, there are more substantive ways, like announcing the third round of Qualitative Easing (QE3) and buying a bunch of Treasuries to flood the economy with cash. That was pretty effective in spiking the market in March 2009 and November 2010, when QE1 and QE2 got under way. Other options include keeping interest rates low, holding back tax increases, and maybe even giving some money away to voters who might stimulate business by spending it.

Past administrations have varied in their ability to affect the stock market. But whether you agree or disagree with its agenda, the Obama administration has been one of the most effective in its ability to get policy through, with or without public approval -- in fact, with or without the approval of Congress.

Don't be surprised to see a strong stock market between now and Election Day. After that, your guess is at least as good as mine.

Related posts:

• The Market Follows a Pattern... Even This Year
• There's More Than What You Read
• Another Day, Another Dollar Easing