Will presidential cycle preside over 2011?

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The graph below, courtesy of Chart of the Day, illustrates how the stock market has performed during the average pre-election year. “Since 1900, the stock market has tended to outperform during the first six to seven months of the average pre-election year. For the remainder of the year, pre-election performance has tended to be choppy and slightly subpar. In the end, however, the stock market has tended to outperform during the entirety of the pre-election year,” said the report.

The theory to support this behavior is that the party in power will make difficult economic decisions in the early years of a presidential cycle and then do everything within its power to stimulate the economy during the latter years in order to increase the odds of re-election. However, given the inordinate size of the punch bowl over the past two years, the historical pattern may not apply in 2011.

Source: Chart of the Day, December 31, 2010.

Putting the theory to the test, Global Macro Monitor researched S&P 500 returns since 1955 and found that the Index has not had a down year during the third year of a first term over this period. As shown in the table below, the average annual return was 21.34%. (The Chart of the Day graph considered all third years, whereas the Global Macro Monitor study only considered third years of first terms.)

Source: Global Macro Monitor, December 31, 2010.

Caveat emptor: Even though the historical evidence on presidential cycles is bullish, there is obviously no guarantee that 2011 will toe the line.

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