Presidential Election Cycle Theory: Meaning, Overview, Examples

What Is the Presidential Election Cycle Theory?

The presidential election cycle theory posits that equity market returns follow a predictable pattern each time a new U.S. president is elected. The theory was developed by Stock Trader's Almanac founder Yale Hirsch. According to this theory, U.S. stock markets perform weakest in the first year of a term, then recover, peaking in the third year, before falling in the fourth and final year, after which point the cycle begins again with the next presidential election.

Understanding the Presidential Election Cycle Theory

Stock market researcher Yale Hirsch published the first edition of the Stock Trader’s Almanac in 1967. The guidebook became a popular tool for day traders and fund managers hoping to maximize their returns by timing the market. The almanac introduced a number of influential theories, including the “Santa Claus Rally” in December and the “Best Six Months” hypothesis, which proposed that stock prices have a tendency to dip during the summer and fall.

Hirsch’s aphorisms also included the belief that the four-year presidential election cycle is a key indicator of stock market performance. Using data going back several decades, the Wall Street historian posited that the first year or two of a presidential term coincided with the weakest stock performance.

According to Hirsch’s theory, after entering the Oval Office, the chief executive has a tendency to work on their most deeply held policy proposals and indulge the special interests of those that got them elected.

As the next election looms, however, the model suggests that presidents focus on shoring up the economy in order to get re-elected. As a result, the major stock market indices are more likely to gain in value. According to the theory, the results are fairly consistent, regardless of the president’s political leanings.

The Presidential Election Cycle Theory vs. Historical Market Performance

A vast number of factors can impact the performance of the stock market in a given year, some of which have nothing to do with the president or Congress. However, data over the past several decades suggest that there may in fact be a tendency for share prices to increase as the leader of the executive branch gets closer to another election.

In 2016, Lee Bohl, a Charles Schwab researcher, analyzed market data between 1933 and 2015, and found that, in general, the third year of the presidency overlapped with the strongest average market gains. The S&P 500, a fairly broad index of stocks, exhibited the following average returns in each year of the presidential cycle since 1933:

• Year after the election: +6.7%
• Second-year: +5.8%
• Third-year: +16.3%
• Fourth-year: +6.7%

Since 1930, the average annual rate of return for the S&P 500 was 6.34%, adjusted for inflation. So while the numbers don’t show a sizable dip in years one and two, as Hirsch predicted, it appears there truly is a third-year bump on average.

However, averages alone don’t tell us whether a theory has merit. There's also the question of how frequently this third-year bump occurs. Between 1933 and 2019, the stock market experienced gains in 70% of calendar years. But during year three of the presidential election cycle, the S&P 500 saw an annual increase 82% of the time, demonstrating a notable consistency. By comparison, the market gained 59% of the time during both years one and two of the presidency.

Donald Trump’s presidency was a notable exception to the first-year stock slump that the theory predicts. The Republican actively pursued an individual and business income tax break that was passed in late 2017, fueling a rally that saw the S&P 500 rise 19.4%. His second year in office saw the index take a 6.2% dive. But once again, the third year marked an especially strong time for equities, as the S&P surged 28.9%.

Limitations of the Presidential Election Cycle Theory

Overall, the predictive power of the presidential election cycle theory has been mixed. While average market returns in years one and two have been slightly sluggish overall, as Hirsch suggested, the direction of stock prices hasn’t been consistent from one cycle to the next. The bullish trend in year three has proven more reliable, with average gains far exceeding those of other years.

Whether investors can feel comfortable timing the market based on Hirsch’s supposition, however, remains questionable. Because presidential elections only occur once every four years in the United States, there’s simply not a large enough data sample from which to draw definitive conclusions. There have only been 23 elections since 1933.

And even if two variables are correlated—in this case, the election cycle and market performance—it does not mean that there’s causation. It could be that markets tend to surge in the third year of a presidency, but not because of any re-prioritizing by the White House team. 

The theory rests on an outsized estimation of presidential power. In any given year, the equities market may be influenced by any number of factors that have little or nothing to do with the top executive. Presidential sway over the economy is also limited by its increasingly global nature. Political events or natural disasters, even on other continents, could affect markets in the United States.

Special Considerations

In a 2019 interview with The Wall Street Journal, Jeffrey Hirsch, son of the presidential election cycle theory’s architect and the current editor of the Stock Trader’s Almanac, indicated that the model still holds merit, especially when it comes to the third year of the term. “You have a president campaigning from a bully pulpit, pushing to stay in office, and that tends to drive the market up,” he told the publication.

However, in the same interview, Hirsch acknowledged the theory is also susceptible to unique events in a given cycle that can influence the mood of investors. He noted that the makeup of the Senate and House of Representatives, for example, can also be an important determinant of market movements. “You don’t want to jump to conclusions when there aren’t many data points,” he told the Journal.

The Bottom Line

The presidential election cycle theory holds that stock market performance may follow a generally cyclical pattern linked to presidential terms. It suggests that in the first year of a term, markets perform the weakest, before recovering and then peaking in the final two years. The idea that the presidential cycle might be an indicator of market performance originated from the Stock Trader's Almanac. It bears out somewhat in historical data: On average, the S&P 500 index has seen its biggest gains in the third year of a presidential term. However, the theory also has notable limitations, including the fact that cyclical trends in market performance are more likely a matter of correlation than causation.