Navigating a U.S. election year stock market

Pat McKeough,

By Pat McKeough,

Special to the Financial Independence Hub

The U.S. election year stock market rule can be profitable for investors in any political climate.

As we’ve pointed out in the past, an election year stock market tends to go on an above-average rise in U.S. Presidential election years. This provides a statistical rationale for optimism in 2016, since the next election is this November. But it’s no guarantee that the market will rise substantially, for a couple of reasons.

First, several ominous factors are weighing on the market right now, in addition to the election. These include the outlook for interest rates; the trend in prices for oil and other commodities; the rise in terrorist activity; the Chinese economic slowdown; and the sharp rise in the U.S. dollar and corresponding drop in the Canadian dollar.

An abrupt shift in any of these factors could have a big influence on the market for the remainder of the year and beyond.

Obama diverging from usual pattern

Second—more important—the election-year indicator works because U.S. politicians have a characteristic way of behaving during these years. President Obama is diverging from the traditional pattern that helped spur market gains in past election years.

U.S. Presidents tend to get a lot friendlier toward business and investors in the second half of each four-year U.S. Presidential term. Stocks usually (but not always) rise in response.

Presidents naturally want to win election for themselves, or their preferred successor. They also want to bolster the prospects of their political party. To do that, they have to win favour with voters. It’s especially crucial for them to charm investors into buying stocks in the second half of the Presidential term.

Rising stock prices help fuel greater consumer spending, which spurs the economy to faster growth. Rising stocks also spur capital spending and hiring, which creates jobs. That’s why a rising stock market tends to make everybody happy. But Mr. Obama has not been participating in this longstanding tradition. Instead of focusing on jobs, incomes and economic growth, he seems more intent on leaving a political legacy.

Usual stock gains may not materialize

With the Obama administration deviating from the past this election year stock market may not have the big gain investors are hoping for. For example in November of 2015, the Obama administration decided not to permit the building of TransCanada Corp.’s Keystone XL pipeline. The President suggested that the project would have undermined U.S. (that is, the Obama administration’s) global leadership on fighting climate change. Environmentalists criticized Keystone for that same reason, and they supported this decision.

TransCanada had already spent $3.1 billion on the project. Not surprisingly, the company has filed a $15 billion damage claim against the U.S. under NAFTA, to cover its lost costs, plus profits it would have made. It claims the decision treated it arbitrarily and unjustly, and that it discriminated against the company in a way that the NAFTA agreement is intended to prevent. However, the NAFTA proceeding can only award damages—it can’t reverse government decisions. Separately, TransCanada filed a lawsuit to reverse the decision, claiming it exceeds the President’s power under the constitution.

Oddly enough, in January 2016 the U.S. offered to help the Kenyan government raise $18 billion to finance its PowerAfrika project, an oil pipeline that would stretch from Kenya’s Rift Valley to Lamu on the coast. This project is similar in many ways to Keystone. However, environmentalists hate Keystone for its connection with oil from the oil sands. The same environmentalists may not object to the PowerAfrika project, perhaps because of its connection with foreign aid.

Does the election year stock market indicator hold true under current conditions?

Before you base an investment decision on the election year stock market rule or any market indicator, you should consider its underlying rationale. See if that rationale makes sense under current conditions.

The election-year rule worked in the past because the President and other incumbents took steps to please a large block of voters: those who want to see rising stock markets, rising incomes, and expanding job opportunities. Today the President is aiming to please a different block of voters who are less interested in financial and economic matters. However, that’s not to say the stock-market outlook is bad.

The market is likely to remain volatile, thanks to those ominous factors we mentioned. But high-quality dividend-paying stocks offer higher current returns than most fixed-return investments. These stocks also provide a hedge against inflation. This combination gives investors a strong incentive to hang on to their stocks as long-term investments. It gives them an incentive to buy more stocks when prices drop.

All in all, now is a good time to invest in a Successful Investor-style portfolio. Our view is that prices will be higher by the end of the year. By then, we’ll be able re-evaluate the market outlook, in light of who wins the Presidential election this November.

Have you profited from the election year stock market rule? Was there a particular presidential transition that was more profitable for you? Share your insights and experiences in the comments.  

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books.

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