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INVESTMENT OUTLOOK : 1988 OUTLOOK : HISTORY FAVORS BULLS : 'Presidential Election Cycle' Suggests Rising Market for Rest of Reagan's Term

December 06, 1987|JAMES F. PELTZ | Times Staff Writer

Investors unnerved by the stock market's recent crash might consider this: If the past is prologue, the market should do fine in 1988 because Ronald Reagan will still be President.

It's not that Wall Street adores Reagan or views his likely successors as bearish for the market and good reason to dump stocks by Inauguration Day. Rather, studies show that stocks historically have been much stronger in the last two years of a president's administration than in the first two years.

This "presidential election cycle" has held true over the past century regardless of whether a Republican or Democrat was in the White House, researchers say. Indeed, contrary to the oft-held perception of the Republicans as the favored party of business, some studies show the market posts higher gains under Democratic administrations.

But even those researchers whose studies have given support to the election cycle agree that the market's crash Oct. 19 raised serious doubts about whether the cycle will repeat itself next year.

They say the crash, together with the subsequent concern over the stability of the U.S. economy and Reagan's lame-duck status, could quickly end the 5-year-old bull market.

The straightforward explanation for the recurrence of the market's election cycle is that presidents want to get reelected, or at least help their party retain control of the White House. So as the elections near, they give an extra nod to voters' pocketbooks.

"They usually try to keep interest rates down, and do anything they can to make the economy look healthy," said said Walter Rouleau, a market historian and publisher of the Growth Fund Guide, a mutual fund newsletter in Rapid City, S.D.

But stocks often suffer in the first half of a term because presidents believe that "it's always best to get any unpleasantries out of the way as soon after an election as possible," he said.

That might mean accepting higher taxes to pare a budget deficit or finance a war, or higher interest rates to cool inflation or boost the dollar. Necessary steps, perhaps, but often bad ones for stocks.

Result: Since 1933 the market, as measured by the Standard & Poor's 500 composite index, has hit its highest point within a presidential term an average of 2.3 months after the election (around inauguration time) and its lowest point an average of 15 months later, Rouleau said.

The cycle was viewed another way by Roger D. Huang, a finance professor at the University of Florida's graduate business school in Gainesville. He found that between 1929 and 1980, the average total return (price gains plus dividends) of the S&P 500 stocks was 6.2% annually in the first two years of an administration, and 15% annually in the last two years.

Huang also found that in the first two years of a Republican administration, the S&P 500 squeezed out only a 0.5% annual average return. Under Democrats, the annual return was an average of 9.8%. And for the last two years of an administration? An average 9.4% return under Republicans, an 18.5% return under Democrats.

John Hekman of the Claremont Economics Institute, a consulting firm, took an updated look at the figures and also found better performance in the last two years of an administration. Between 1926 and 1986, he found the total return of the S&P 500 was an average 7.8% annually in the first two years, and 16.6% annually in the last two years.

Even investors who haven't calculated the statistics know that the last three major bear markets in stocks--in 1969-70, 1973-74 and 1981-82--occurred during the first two years of an administration.

Not that the cycle is ironclad, particularly in recent times. The current bull market began in the summer of 1982--Reagan's second year in office. During the first two years of his second term, in 1985 and 1986, the Dow Jones industrials jumped 27.7% and 22.6%, respectively. And, of course, the market has been on a roller-coaster ride this year.

Despite those recent exceptions, the researchers said investors should not dismiss the presidential election cycle simply as mere coincidence. Hekman said the cycle is further buttressed by the fact that nine of the last 11 recessions in the U.S. economy since 1929 also have started in the first year of a president's term.

But the researchers do not suggest that the presidential election cycle is by itself a reason to "time the market," that is, to abandon stocks during the first half of an administration and then re-enter the market for the second half.

Many professional money managers believe in the cycle, "but it doesn't necessarily mean they're going to build their investment decisions around it," Hekman said.

Will the election cycle occur again? Rouleau has his doubts.

"This time around things are different," he said, referring to the historically high levels reached by the market earlier this year. "Usually when things go to such extremes, there's a high probability you will go to extremes in the other direction. In order to do that, we'd have to go quite a bit lower than we are now."

By that reasoning, 1988 could be a down year for the stock market, breaking the typical election cycle. Still, researchers advise, don't count out the election cycle just yet.

History, they say, has a way of repeating itself.

THE STOCK MARKET'S "PRESIDENTIAL ELECTION CYCLE"

For many decades the stock market has followed a pattern in which share prices move higher, on average, in the last two years of a president's administration than in the first two years.

Standard & Poor's 500 Average Annual Total Return *

1926 - 1986 Administrations

1948 - 1986 Administrations

* Price gains plus dividends

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