Let’s explore the connection between your investment portfolio, a couple of planets, Kris Kringle, and an election year. Since the dawn of time, we humans have been tracking cycles – from the moon to animal migrations, and everything in between. We are hardwired to seek predictably, it is part of our quest to understand the world around us.
Just as we know that Jupiter will align with Saturn every few decades, we can also open a copy of the Farmer’s Almanac and know the exact phase the moon will be in on that specific night. Through large data sets and tracking, we begin to unlock the ability to predict future occurrences, with reasonable reliability.
The stock market is no different with its large sets of data, predictable patterns, and a few unexplained but consistent occurrences. That brings us to Ol’ St. Nick.
The Santa Claus Rally
First recorded by Yale Hirsch in the Stock Trader’s Almanac in 1972 – the Santa Claus rally is a unique but fairly predictable phenomenon. What Hirsch found is that if you take the last 5 trading days of the year, and the first 2 trading days of the following year – if those trading days are positive, then generally the next year is going to be a good year for the stock market. So if Santa Claus “shows up”, then generally you can expect a decent year for your portfolio.
Now, this is by no means a guarantee, but more like a weather forecast – we know what to expect, but of course, predictions can sometimes fall short.
Similar to the Santa Claus Rally, there are some persistent themes to consider when investing during and after an election year.
The President Election Calendar Anomaly
Like studying the movement of planets, we can understand and predict some general trends with the stock market and a Presidential Election Calendar. Here is what we can often expect:
Regardless of which political party takes office, the first year of a newly elected President’s term is generally the most volatile of the four years. Logically this makes sense as a new President is spending the majority of the first year building out their cabinet, rather than passing new legislation. Generally, a new President is a little slower to react to economic changes and quick to assign the blame to the former outgoing President.
Year 2 usually performs slightly better than the first year, but the really interesting bit is what happens in year 3.
Year 3 returns are generally very good. In a study of over 13 election cycles, year 3 averaged returns of 23.5% per year for large stocks, without any losing years. There are many different theories for this anomaly, but again, it makes sense when we think it through. A newly elected President is starting to hit their stride in their third year and is also beginning to eye the prospect of an upcoming shot at re-election. This is when we generally start to see business-friendly tax cuts and attempts to boost the economy. A president up for re-election has a strong incentive to pump up the economy and send voters to the ballot box with a sense that they are in a strong financial position. In the fourth-year, we see higher returns than the first and second, but generally not as spectacular as the third.
So given all that we know, what does this mean for your portfolio?
I can already see the wheels spinning – so given all that we know, let’s adjust our portfolio positions to boost our overall returns, right? Not so fast. While each of these anomalies is fascinating and occur often enough to be statistically significant in the world of investments, they are not something to use to navigate a portfolio. More than anything, these anomalies can provide some additional understanding into what we could expect with a new president in office over the next four years. This can help us avoid being surprised if the first year is a little rocky, and if we see some big returns in the third year, well, we suspected that might happen.
Studying, tracking, and identifying patterns are some of the traits we use to understand the world around us. This leads us to discover many interesting anomalies, often without much of an explanation. While this information is powerful to help us understand the timing of ups and downs, it is not something we want to build an investment portfolio around. A winning portfolio requires an understanding of investment fundamentals such as diversification, fees, various asset classes, and much more. That being said, next time you hear about the Santa Claus Rally, you will know what it means and just like forecasts of a good or bad hurricane season, you’ll have some insight into what to expect.