A buy signal for US stocks

published 5 December 2014

The third year of each US presidential term has consistently been bullish for US stocks especially the first seven months.

Since 1932, the market has returned an average of 17% between1 October and 30 April, equal to a gain of 2.5% per month, says Jeremy Grantham of asset manager GMO.

By comparison, the remaining five months of the year have averaged 0.75% each, while the average across the other three years of each four-year term is just 0.2%.

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Of course, averages can sometimes disguise extreme outcomes, but in this case, 17 of the 20 cycles so far have had positive returns, while the worst of the three down years was a modest loss of 6.4%.

While this pattern could simply be a fluke, the odds are against it: as a result, being bullish on US stocks"may seem like a no-brainer investment" for anybody "not intimidated by the obvious simplicity of the idea", says Grantham.

So why does this market quirk exist? "The most likely explanation is thatmid-term elections tend to increase gridlock in Washington," saysEd Yardeni of Yardeni Research. "While the debt-ceiling political crises of August 2011 and late 2012 suggested that too much gridlock is bearish for stocks, it has been quite bullish historically."

It seems that America's "system of checks and balances, designed to limit the folly of our foolhardy politicians", ultimately produces outcomes that favour investors. Given that, it's notable that the latest elections produced a gridlock-friendly outcome: Republicans in control of both houses of Congress, with a Democrat as president.

This combination has historically been bullish, coinciding with the highest average return in election years, says The Economist's Buttonwood columnist almost 13 percentage points better than the worst combination of Republican president facing Democratic control of one or both houses. "These figures indicate the market is right to be relaxed."

That said, whether these patterns will work this time is an open question. Other events bode ill for markets, including the end of quantitative easing in the US, the threat of interest-rate hikes and geopolitical tensions.

"Going into this cycle there appear to be more negatives than normal," agrees Grantham, but many of the previous 20 occurrences may "have seemed that way at the time".

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.