WASHINGTON (TheStreet) — Stock market returns are influenced by many factors. Interest rates, economic growth, currency exchange rates and expectations about the future play a part in returns, making projections difficult and risky.
One way to predict market performance is to look at presidential administrations. This may seem a little spurious at first, but the logic actually follows quite nicely.
Jeremy Grantham, chairman of the Boston-based asset manager GMO, echoed research by Marshall D. Nickles of Pepperdine University while speaking at the CFA Institute Annual Conference last week. Nickles' research, published in 2004, says the first and second year of a presidential term is usually marked by declining stocks. In the third year, stocks often generate above-average returns before retreating to averages in the fourth year.
This makes sense when you consider the way in which power is transitioned in the U.S. When the new administration takes over, the transition period is a lot of logistics and housecleaning while policy slowly takes shape. The first few quarters of a term can be a mishmash of old policy and new as the table is set for the next four years.
At this point, investors and companies are feeling out the new president to get an idea of how the next four years will play out and how their business may be impacted by Washington. This tentativeness can make buying slow and make bulls hesitant, keeping a lid on gains.
The second year sees more of the same as the first midterm election gets underway and the administration starts to get down to the business of putting in place objectives that may not have been marquee campaign promises, but are still viewed as critical to its vision.
By the third year, the vision for America that brought a president to the White House has likely taken hold and the country is probably feeling the effects of the regime's policy, without influence from the previous administration's actions on interest rates and spending. At this point, fiscal and monetary policies made under the previous leader no longer impact the new administration, which can take responsibility for the success or failure of the market and economy.
Nickles suggests in his 2004 paper that the most attractive strategy to exploit these trends would be to push into the stock market on Oct. 1 of the second year of the administration and sell out on Dec. 31 of the fourth year. This strategy would have turned $1,000 into $73,000 between 1952 and 2000. Those gains would have been severely hurt in the last year of President George W. Bush's tenure, when the market collapsed in the subprime crisis.