A few weeks ago I wrote that the extreme stock market volatility that occurred during the second half of 2011 seemed to have subsided. That trend has continued since then. The biggest single day decline of the S&P 500 in January was 0.6%. During the last 6 months of 2011, there were 44 days in which the S&P 500 declined by more than 0.6%. This is consistent with our proprietary model that analyzes factors that impact volatility. All of those factors (a low level of interest rates, a below average price-earnings ratio, good stock price momentum, and low recent volatility) are positive, which suggests below average market volatility in the coming months.
Of course, with very little market anxiety to write about, financial columnists have started to search for other potential stories. Many writers are opining on how the presidential election will affect the stock market, using anecdotes or selected historical data to make their case. I thought it might be useful to look at the data to determine how the market reacts in presidential election years.
A common theme of stories suggests that in general, election years are good for the stock market. This is popular mainly because four years ago many money managers were actively promoting a “Presidential Cycle” theory, based on a result that since 1948, the stock market had earned an average return of over 12% in election years. So, how did that “theory” work out in 2008? – the S&P 500 lost 37% of its value. Nonetheless, various pundits are rehashing the theory for this year.
Another theme is that a win by one party or another will have significant impacts on the stock market. The data is surprising in this regard. On average, since 1926, the S&P 500 provided an annual return of 6% while the President was a Republican, and 14% while the President was a Democrat. Does that mean that one party is better for the stock market than the other? Well let’s look at stock market performance under the previous two Presidents to see what occurred. Between 1993 and 2000 (during the Clinton Administration) the S&P 500 earned an annual return of 17%. Most of that return can be attributed to economic growth and productivity gains caused by the technology boom. It seems difficult to credit much of that growth directly to economic policies enacted during that time. Over the next 8 years, the S&P 500 declined in value by 3% per year. Most of that drop occurred because of a reassessment of values of the technology boom, concern over 9/11, and the banking crisis. Certainly the first two factors cannot be attributed to any of the policies of President Bush. My point is the vast majority of what occurs in the stock market is independent of presidential politics, and differences in stock market returns are more likely the result of random concurrent events.
A final theme of articles is that 2012 will be a volatile year because of the election. The best way to measure volatility is standard deviation. Historically, annualized standard deviation of stock returns in non-election years is 16%, while the standard deviation in election years is … yawn … 16%. What this suggests is that while many factors affect market volatility, the election does not appear to be one of them.