By Mark Hulbert
U.S. stocks typically are flat during the second year of a presidential term – and soar in the post-midterm election third year
Focus on economic uncertainty, not the presidential election-year cycle.
The U.S. stock market has performed even worse since the November 2024 presidential election than followers of the presidential election-year cycle expected.
According to this well-known indicator, the stock market typically does poorly in the first two years of a president’s term. That’s because presidents, regardless of political party affiliation, have an incentive to deliver economic medicine early in their term – so that it doesn’t jeopardize their party’s chances in the midterm election.
Yet historical data shows that had the Dow Jones Industrial Average performed as well since last fall as it has in every presidential cycle since the Dow’s creation in 1896, the index would be higher than it currently is. (Note that the chart follows the convention used by most studies of the presidential cycle and focuses on fiscal years beginning Oct. 1.)
What to know about the presidential election-year cycle
There’s another reason that the market’s current condition is hard to square with the historical data: The stereotype of the presidential cycle is only partially correct. On average, in fact, the first year of the cycle is unexceptional, producing returns that are close to the stock market’s long-term average.
As you can see from the chart above, the second- and third years typically deviate from the long-term average, with the stock market essentially flat during the second year and soaring in the post-midterm third year.
The source of these unusual returns during the second and third years of the presidential term appears to be above-average economic uncertainty during the months leading up to midterm elections. That’s according to research from Terry Marsh, an emeritus finance professor at the University of California, Berkeley, and Kam Fong Chan, a professor of finance at the University of Western Australia. They reported their results in a study entitled “Asset prices, midterm elections, and political uncertainty,” which appeared in the Journal of Financial Economics in 2021.
The professors found that, on average in the months prior to midterm elections, the Economic Policy Uncertainty Index tends to be above normal. Since investors demand additional compensation for the higher risk, the stock market must first decline. After the midterm election, the elevated uncertainty is at least partially resolved and the stock market typically rebounds.
The implication of this research is that investors shouldn’t be focusing on the presidential election-year cycle itself but on economic uncertainty, since the election-year cycle is basically a proxy for it.
For example, the Global Economic Policy Uncertainty Index recently rose to its highest level on record, as you can see from the chart above. The uncertainty it’s reflecting has exceeded the typical presidential election-year cycle pattern, and that helps to explain why the U.S. stock market is lagging what followers of the pattern would normally expect.
In fact, if you believe investors’ uncertainty will rise even higher, then you would want to underweight equities until you’re convinced that the Uncertainty Index has plateaued or will decline.
Determining the timing of this trade is easier said than done, but focusing on the presidential election-year cycle, instead of directly on economic uncertainty itself, only makes that decision more difficult.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
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-Mark Hulbert
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05-20-25 1440ET
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