The theory of the stock market “election cycle” holds that stocks tend to perform better late in a presidential term than in the immediate post-election period. The presumed causal dynamic is straightforward. Going into an election, the party in power wants a strong economy; consequently both GDP and stock prices tend to be strong in the last two years of a presidential term. Conversely, it is politically safest to restrain inflation early in a presidential term; if this requires a recession that lasts a year or so, it will set the stage for a nice economic rebound in the second half of the term — just in time for the next election.
During the four years of a President’s term, the postelection year has, historically, been the worst for stocks, with a median performance of -1%.
The median performance of the DJIA in the post-election year of eight postwar first-term Presidents was -5%.
The median performance of the DJIA in the post-election year of five “high expectation” first-term Presidents was -9%.
George W. Bush is leaving office with a relatively low job approval rating of just 34%; his successor is entering office with almost three-in-four Americans (72%) holding a favorable opinion of him. As Figure 2 illustrates, this “popularity gap” of 38% (= 72% - 34%) is the widest in the postwar period. Clearly, expectations are high for President Obama. However, those expectations may prove to be a risk for investors in 2009.
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