Election Years Bring Stock Gains

Last year's political gridlock did a number on the stock market, as Washington brinksmanship (among other crises) translated into frustration on Wall Street. This year, though, politics might work in the market's favor. That's because the market has traditionally gone up in election years.

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Since 1900, when Republican William McKinley won reelection to the White House, the Dow Jones industrial average has gained an average of 7.3% in presidential election years, according to InvesTech Research, a market-research firm. If you exclude 2008, the depth of the financial crisis, the average gain climbs to 8.8%. Top stock sectors in election years: energy and consumer staples, says Standard & Poor's.

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Time to call your broker? There's no rush. Election-year gains often come in the final months; for much of the year, the market is directionless as investors anguish over the upcoming election. And anyway, the current four-year election cycle has been anything but typical. For example, year three is usually the best year, with the S&P 500-stock index logging an average 17% gain going back to 1941. Last year was year three in the current cycle, but the S&P finished flat. Which opens up a statistical can of worms. When Sam Stovall, S&P's chief equity strategist, looked into election years that were preceded by disappointing third years, he found that the S&P fell in five of those six cycles; the average election-year decline was 10% (the nearly 40% decline in 2008 didn't help).

A third shuffling of the statistical deck shows yet another, more positive facet of election years. Paul Hickey, of Bespoke Investment Group, has found that market gains in election years in which an incumbent is running are nearly double, in percentage terms, the gains logged when incumbents are not running.

Numbers aside, the rationale for election-year gains is simple. They aren't as much caused by the election as they are correlated with an election campaign. "If a president has any political foresight, he will get the bad news out of the way early -- such as policy decisions that might slow the economy -- so that by the time he's running for reelection, the economy is firing on all cylinders and the path to the White House is paved with rising confidence and rising stock prices," says Inves­Tech's Jim Stack. Few people would characterize the current economy as "firing on all cylinders," although some recent indicators have been encouraging.

If past elections offer a murky view of how the market will do, looking at what the market is doing provides a clearer picture of how the election will turn out. Just watch the Dow in the two months before the election. Gains or losses during that period augur a win or a defeat, respectively, for the incumbent party, with a nearly 90% success rate.

And if you really want to go crazy with statistical indicators, consider two of them together. The "January barometer," which says that gains in January portend gains for the year, looks good: The S&P 500 rose by 4.5%, its biggest first-month gain since 1997. Even better news, according to Stovall, is that the January barometer, when it points to full-year gains, has a 100% accuracy rate in presidential election years.