Research has shown that the stock market tends to follow the presidential cycle. The market usually goes up during the presidential election year, and 2016 has certainly followed form. The S&P is up some 11 percent this year and the Dow Jones has risen 14 percent. During the last 10 presidential election years, including this one, the market has been up eight times, and down only twice. That's an 80 percent probability. That's not bad odds. But what happens next?
Ned Davis Research long ago identified the presidential trend. Stock market average returns during the lasttwo years of a presidential term are significantly higher than those during the first two years. A separate study by Marshall Nickles of Pepperdine University including data going back to 1950 also concluded that the stock market tends to be strong during a president's third and fourth years in office, but posts a relatively weak performance at the beginning of the term. The Dow Jones Industrial Average is an average of 7.2 percentage points higher during the third and fourth years of presidential terms than in the first two years, the study found. However, Nickles points out some exceptions to this trend in which performance was higher in the first two years of a presidential term, including 1985 to 1988, 1997 to 2000 and 2005 to 2008.
Nickles and others caution that while the presidential cycle theory is historically accurate, it does not necessarily predict stock prices. The market is subject to various forces, many of them unforeseeable, such as whether or not the Federal Reserve raises interest rates. Therefore, cautions Nickles, a recognized pattern may not anticipate the next turn in the market. Ask anyone who invested in 2008, an election year when prices were supposed to go up. Instead, the S&P lost a staggering 41 percent. Then in the first year of Barack Obama's presidency, when prices were supposed to be weak, the market galloped ahead by 26 percent.
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Nothing in this world is certain, and the stock market is a game of probabilities. A 2014 report from The Leuthold Group confirms the theory that the market ekes out small gains during a president's first two years – with the post-election year generally the weakest – and then goes up a lot during the president's second two years.
Does it matter that Donald Trump won the election instead of Hillary Clinton? Some investors believe Republicans are good for business, on the theory that they lower taxes and impose fewer regulations, leading to higher corporate profits. But it's possible that less regulation eventually allows for more exploitation and self-dealing which undermines confidence in business, and if Republicans try to rein in the deficit, they might cut federal spending which could squeeze profits of major companies doing business with the government.
The fact is, over time, neither Republicans nor Democrats have proved better or worse for the stock market. Meanwhile in 2000, the last time a Republican took over the White House from a Democrat, the S&P 500 lost 10 percent. But going back to 1980, when Ronald Reagan beat out Jimmy Carter, the stock market jumped up nearly 27 percent.
Still, if we believe in the presidential cycle, we might be well-advised to enjoy the Trump rally while it lasts, but then be ready to scale back when he is inaugurated in January. Or we might wait until April, since other research has identified an annual cycle in stock prices. According to The Leuthold Group and others, stocks tend to outperform from November through April, then struggle from May through October.
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When considering our IRA or 401(k), we should usually take the longer view that over time stocks increase on average about 7 percent a year, which is a lot better return than you can expect from a bond or a bank account. But people approaching retirement should be more conservative than younger investors and should slowly and deliberately decrease their exposure to the stock market. Perhaps the new year brings us the opportunity to sell some of our positions at historically high prices and avoid the risks that come with any new presidential term.
Tom Sightings is the author of "You Only Retire Once" and blogs at Sightings at 60.
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