Stock Market is nothing but an aggregate or sum total of daily activities of millions of investors, traders and institutions who buy or sell on a given day as per prevalent sentiment, political and economic realities. Political situation in any country affects the stock market morale due to economic policies of particular parties and general elections have the potential of changing the course of economy of a country. And when the country in question is United States of America, the policies affect not only the domestic economy of USA, but the whole world, and especially countries like India which have strong business ties with USA.
How Obama v/s Romney Presidential Race in USA will affect your portfolio?
The answer lies in 4-year Presidential Cycle theory, which is based on analysis of number of years of election data, and how it affects the economy and stock market returns in the years preceding and following the elections. As global markets are tightly integrated now, e.g. a Bullish day in Dow Jones index often creates a gap up opening in Nifty the next morning. Similarly, results of US elections have significant potential of affecting Nifty returns as well.
Based on a number of studies done over past many decades by Yale Hirsch, creator of Stock Market Almanac, it is statistically proven that Stock Markets in USA follow a four year cycle, which closely follows the 4 year election schedule.
In the first year of the presidential cycle, as a new president is elected or incumbent retains his seat, the stock market returns are typically weak. This is a toughest year for the economy and stock market, as new government tries to bring a balance between inflated election time promises and ground realities of the economy. New president often realizes that promises he made to electorate are difficult to implement, require a multi-year effort, or simply not doable. So, economy slows down, public perception and sentiment gets affected and resultant stock market returns are least attractive. Average returns by stock market for first year of presidential cycle are in the range of 5-7% for the year.
Second year of presidential cycle, marks a slow and gradual uptick in economy, as new president starts getting his promised policies in action by now. The economic and political decisions initiated in year one start showing result by year two of cycle. If there was a bear market in stock market in first year, the second year will mark the bottoming of this bear market and hence is a good time to start buying equities at good value prices. Average returns by stock market for second year of presidential cycle are in the range of 8-10% for the year.
Third year of presidential cycle is often strongly bullish. This is because the economy adjusts to the new policies by now, and visibility to industry heads is highest. There is stability in system by now, as there is considerable time before the next election approaches, so capital spend is highest in industry and government. Government starts opening their coffers now for various public schemes as they are aware of the impending elections by next two years and hence extra money in system creates a bullish year for economy and stock market. Average returns by stock market for third year of presidential cycle are in the range of 20-22% for the year.
Fourth year of presidential cycle is culmination of policies taken during the past four years. The year is moderately bullish as Industry realizes that political scene might change in next year or so, so there is caution in air. However, public policies are at their lenient and there is considerable liquidity in system to maintain the high stock market levels. The markets are stable and at their four year highs at this point of time of four year cycle. Average returns by stock market for fourth year of presidential cycle are in the range of 8-10% for the year.
This cycle repeats every four years of economy and by being aware of this cycle investors can benefit by timing their entry in equities market. Investors can carefully start investing in second year of presidential cycle when equities are at their lowest levels. After a bullish year three and year four of the cycle, investors can slowly start taking profit off the table by end of year four of the cycle.
Additional complexity in the cycle can come, when there is a regime change at the top. i.e. When a Republican candidate upsets the Democratic regime or vice versa. Like if Romney stages a victory over Obama, how will markets react? Or if the incumbent candidate is chosen for a second term, i.e. if Obama has a second term by defeating Romney, how will markets react?
Typically, studies suggest that Democrat presidents are generally better for stock markets than their Republican counterparts. The Republicans are pro-large business typically, however stock market returns have been superior under Democrats historically. One reason could be due to pro-general public policies of Democrats, inducting liquidity through public schemes and favorable schemes for common public, which may induce feel good factor and stock market purchase by common retail investor.
Historically, it is very tough to beat an incumbent party in US elections. Out of last 14 incumbent presidents which tried for a second term re-election, only 4 have failed. Hence statistically, it is far more probably for Obama to win this re-election, than Romney being able to create an upset victory. Again, re-election of a given president is very positive for stock markets, because investors and industry captains are aware of existing economic and political policies. Re-election of an incumbent president will not create any surprise factor or change in top level policies, hence paving way for a stable economic regime. Re-election of Democratic president for a second team have provided about 14-15% gains in first year of re-election.
Hence for a Indian equity investor, re-election of Obama would be a positive for your portfolios and surprise win for Romney might create lot of confidence in large economic business houses in US, due to pro-business stance of Republicans, however may not be very positive for stock markets in initial 1-2 years of presidential cycle.
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