The S&P 500 tends to outperform in the third year of a presidential term
The third year of a Presidential cycle is well-known to be bullish for stocks. This week, I’ll be looking at the historical numbers that put that theory to the test. There are a few theories as to why the third year would be so good for stocks. Maybe investor confidence grows when the new Congress begins. Another possibility is that Presidents begin eyeing the next election in their third year and promote market friendly policies to boost their chances of winning. Of course, it’s also possible it’s random and that’s just the way it has turned out. Whatever the reason, the stock market performance over the last 70 years in the President’s third year after an election has been impressive.
Third Year Presidential Cycle
In 1949, Harry Truman became the first President to be inaugurated to his first term on the date Jan. 20 (prior to Franklin Roosevelt’s third term, Presidents were inaugurated in March). We’re in the middle of the 19th four-year cycle since then. The table below summarizes the yearly returns on the S&P 500 Index (SPX) for each of the Presidential cycle years. The third year has been a positive outlier.
The average return in the third year of the cycle has been 16.8%, which trounces any of the other years. Half of the returns were better than 18%. The next best average return occurred in the first year of the cycle with an average return of 8%. Out of the 18 cycles, the third year was negative just two times. Those two times, the S&P 500 lost 0.7% in 2015 and 0.003% in 2011. So, in the two down years the index lost less than a percent. That’s the reason for the high average return.
Often overlooked about the third year of the cycle is when those gains occur. If you’re playing the seasonality, now is the time to buy in. The first half of the third year has been extraordinary, to say the least. The table below shows the first six months of the third cycle year has averaged a gain of 12.6%, with all 18 of the returns positive. The second half of the third year has averaged a much softer return of 3.93%. Since the second half of the year has typically been bullish, that’s the lowest average return of the four cycle years.
After Negative Years
Since we just had the worst year for stocks in a long time, I wondered how the third year performed after stocks suffered in the prior year. In these instances, the third year of the cycle has been a huge bounce-back year. In the eight years that the second year of the cycle was negative for the S&P 500, the third year averaged a gain of nearly 25%, with all eight returns positive. After a positive year, the index averaged a gain of about 10% with 80% of the returns positive.
Finally, here’s a table showing the individual returns for the S&P 500 in the third year of a cycle following negative years. The biggest losses in the second year of the cycle have tended to be followed by big gains the next year.
