The election year investment theory seems to be playing out as the benchmark US indices are trading near their five-year highs.
The Dow Jones Industrial Average, closed up 69.07 points at 13,323 on Tuesday, the highest close since the end of 2007. Market experts attribute the rise to the Federal Reserve meeting and possible quantitative easing, coupled with the pending German court decision on euro zone's new bailout fund. However, the role of US presidential elections in this development cannot be completely overlooked.
Yale Hirsch, an investment advisor and founder of the Stock Trader's Almanac, developed a prominent election-year investment theory. In the Presidential Election Cycle Theory, Hirsch says stocks decline in the year immediately following the presidential election, then go up over the course of the next three years, no matter who wins the election. His theory says that in the fourth year of the presidential term and the election year, the stock market's performance tends to be above average.
There are several examples to back his point. In 1937, the first year Franklin Roosevelt was president, the market was down more than 27 per cent, then went up in the following years. The Truman and Eisenhower terms also followed the same pattern. Similarly, following the election of George H W Bush, Dow rose by 25 per cent and rose almost by 20 and 35 per cent respectively, following Bill Clinton's election.
There have been other studies to prove this idea. In his 2004 study 'Presidential Election and Stock Market Cycles,' Marshall Nickels of Pepperdine University analysed stock market bottoms in relation to the presidential cycle. He said that in the period from 1942 to 2006, there were 16 presidential terms and 16 market lows corresponding to those terms.
Three of the lows occurred in the first year of the presidential term, 12 in year two, one in year three and none in year four. Of the 16 bottoms, 15 occurred in the first half of the term and only one in the second half of the term.
However, there was a downfall seen in Dow post the election of George W Bush, contradictory to the theory. In the year of Obama's election in 2008, the Dow dropped to new lows, where for the year 2008, Dow Jones Industrial Average fell 33.8 per cent. There are also other theories that say that Dow performed better only when there is the chance of an incumbent party's victory.
Romney and Obama will clash in the next two months, in what is being called the most closely watched presidential election battle in the United States.