The U.S. Presidential Cycle Points to a Volatile Year Ahead
To kick off the new year, we warned readers that January was going to be tough.
And we warned that regardless of the wide-eyed optimism and the thesis that “January is a great month for stocks,” the opposite is actually true.
The declines and volatility we told investors to expect in the first month of the year have already started to play out.
You see, part of our investing approach here is “one month at a time.”
We look at how the markets perform in each month. Because if we can recognize historical market trends, we won’t be blindsided by volatility or declines. Instead, we can use those to our advantage.
But we also take much larger market trends into account.
And one of my favorites to turn to is the U.S. presidential cycle.
This is a surprisingly accurate model that every investor needs to take into consideration.
Back in 2016, during a tumultuous election, I predicted that the S&P 500 would increase 19% in 2017 no matter who won… which unfolded.
Two years later, I used this model to forecast the “Great Correction of 2018”… which we got.
In 2019, I turned to this historical trend to forecast a 17% return that year… which happened.
It’s what I used to warn investors that 2020 was going to be a turbulent year for the markets… which may have been an understatement.
And it’s what I used to forecast that the markets would gain more than 16% in 2021… which also came to fruition.
For many investors, this model seems too simple to be believable. But every year, I roll out my yearly forecasts based in part on this cycle. And time and time again, it proves to be accurate.
So what can the U.S. presidential cycle tell us about 2022?
From Ronald Reagan to Joe Biden
Years ago, I created an updated version of the U.S. presidential cycle.
Since U.S. indexes routinely replace components and the political climate changes, we need to use historical models that reflect our modern era.
You see, when we break this trend into periods, we can see major shifts in performance.
Traditionally, investors believe that the third year of a presidential term is the strongest, followed by the fourth, second and first. That model uses data going all the way back to 1901.
But the current average performance is dramatically different.
My U.S. presidential cycle uses Dow Jones Industrial Average data going back to 1988.
And this is more reflective of our modern era.
As we’ve seen over the last nine presidential terms, the Dow’s best years – by far – have been the first and third years.
During the first year of a new term, the Dow is averaging a 16.06% return. And in the third year, the blue chip index’s average gain is even better at 17.22%.
Last year was the first year of the new presidential cycle. And right on cue, the Dow gained almost 19%.
There’s always a lot of optimism and momentum in that first year. For the most part, regardless of what’s happening at the macro level, stocks rally. We saw it in 2017, and we saw it again in 2021.
However, the second year is a different story entirely…
The Honeymoon Is Over
For investors, the honeymoon period of a new presidential term ends in the second year.
All of those promises from Congress and the White House – and all of the bills that were sure to be passed – don’t really come to fruition.
They almost never do.
Added to the combustive nature, we have midterm elections. These have become more fractured and bitter over the last couple of decades.
One side is desperate to get something passed to warrant reelection. The other side wants to prevent that from happening.
In turn, everyone suffers. The markets struggle for traction.
Investors hate uncertainty. And the second year is chock-full of it.
In fact, the Dow is averaging a pinch over a 3% return in the second years of my U.S. presidential cycle.
So don’t look for stocks to post another double-digit gain in 2022. This is a year for tempered expectations, particularly in light of inflation, and the Federal Reserve raising rates while rapidly scaling back its tapering.
Of course, we’re also entering another year of the pandemic.
That’s a lot of headwinds.
I learned very early on in my career that projections that are too far out are almost always wrong.
But when we focus on much shorter time frames – such as the month or year ahead – using updated historical models, forecasts can be a lot more accurate.
History tells us that the second year of the U.S. presidential cycle is a bummer for stocks. And that’s okay. There are plenty of opportunities for short-term gains in sideways or volatile markets.
We just have to be prepared to embrace the volatility.
Here’s to high returns,