Especially during these times of economic uncertainty, being able to predict the future with 85% accuracy is a tantalizing prospect. Surprisingly, we can predict stock market performance with that degree of accuracy if we consider that over the past 21 presidential-election years, 18 have shown positive returns for the S&P 500.
According to “Presidential Puzzle: Political Cycles and the Stock Market,” a 2003 paper published by Pedro Santa Clara and Rossen Valkanov of UCLA in The Journal of Finance, the most lucrative approach may be to buy equities on Oct. 1 of a president's second year in office, then sell out on Dec. 31 of the fourth year.
Amazingly, that simple timing strategy would have sidestepped most down markets over the past 60 years.
The reasons for strong election-year performance have been the topic of much speculation. A leading theory suggests that administrations may use fiscal policy such as changes in taxation and government spending to tip voter sentiment in their favor.
Politics aside, history also shows that the S&P 500 tends to perform better under Democratic administrations (11% average returns) than under Republican (2% average returns).
A significant exception to these trends, of course, was in the wake of the 2008 financial crisis, where instead of strong market performance, we saw one of the worst downturns in almost a century.
As we look out over the 2012 horizon, there are a slew of worrisome challenges — including structural deficits, which can be addressed only by decisive government action; economic uncertainty, which has prompted many investors and businesses to postpone decisions and hoard cash; tax uncertainty; and Middle East turmoil, which continues to feed rising oil prices.
With these in mind, what strategies should clients consider?
Here are our top five:
Short-term taxable fixed income. With U.S. interest rates near historic lows, corporate and government bonds could be in for a tough time. Some analysts are even describing how the 30-plus-year bull market for bonds, which began during Paul Volcker's tenure as Federal Reserve Board chairman, is likely at an end. Certainly, as market rates rise, bond values decline. So we are well-advised, even with laddered portfolios, to stay under five-year maturities and minimize exposure to bond funds.
Municipal tax-free bonds. Although rising rates typically have a detrimental effect on munis, a wild card could be a rise in income tax rates, which would drive demand.
Dividend-paying stocks. With yields on many equities exceeding 4%, income-hungry investors have been flocking to this sector. Cash-flush corporations are increasing dividends to their shareholders, as well as initiating stock buyback programs, both of which could support appreciation in this sector. With so much global uncertainty, the United States may be deemed the safest haven around.
Commodities. There is considerable speculation that inflation already may be here and perhaps isn't being accurately tracked by the government's Consumer Price Index. Besides gold, which has enjoyed a tremendous run-up over the past few years, a diversified basket of commodities may offer opportunities to preserve purchasing power.
Real estate. Historically one of the best inflation hedges, commercial and residential real estate are likely near their lows. Ironically, some analysts predict that rising interest rates could offer a stimulus antidote, as banks would find it increasingly profitable to lend money in support of this battered sector.
Certainly, as we near the November election, many hope that lawmakers from both parties will recognize the value of being able to reach across the aisle and work on meaningful bipartisan solutions. Knowing that historical trends favor positive market performance this year can give us solace as we navigate these challenging waters.
Mitchell Kauffman is managing director of Kauffman Wealth Services Inc.
