Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
EQ: As we discussed in our last interview, January is a big month for the market, particularly the first week’s performance. But given that 2012 is an election year, should investors pay even closer attention to the January Barometer?
Stovall: Yes, I think they should. The January Barometer, which has been popularized by the Stock Trader’s Almanac, states, “As goes January, so goes the year.” Certainly, when it comes to positive Januarys forecasting positive full-year performances, the 86-percent success rate going back to 1945–and notwithstanding its failure in 2011–is quite an enviable track record.
The January Barometer is even more important during presidential election years because in the eight times since World War II that the market was up in January in an election year, the full year was up 100 percent of the time. So the January Barometer worked eight out of eight times. While that doesn’t guarantee that it will work this time around should the market be higher in January, it could certainly give investors a bit of comfort thinking that at least the odds favor the January Barometer being an accurate forecaster. But right now, we’re not even out of the first week of January, and as some investors know, the first five days is traditionally an early warning signal for the full month, which in turn, is a good indicator of the full year.
EQ: Looking back at how the market performed in 2011–the third year of the current presidential cycle–are there any reasons for investors to think that 2012 might not be a normal election year?
Stovall: Yes, there are. Here is where historical patterns tend to say two different things. First off, we don’t know whether the market is going to be up in January, so we don’t know whether the January Barometer is going to be successful or not. But, going back to the late 1920s, whenever the performance during the third year of a president’s term in office has been less than 8.5 percent, the market has declined an average of 10 percent in the fourth year, and falling in five of the six observations. When this happened, the performance in the third year was basically less than half of what the normal return has been, and whenever we have had a subpar performance of that sort, we’ve basically experienced a dismal fourth year.
I think the reason is because of the psychology behind what drives the third year of a presidential cycle. The party in power wants to stay in power, so they’re going to do whatever they can to stimulate the economy so that when time voters go back to the polls, they’ll feel good and hopefully re-elect the sitting president. If the existing president really hasn’t been able to push through a lot of stimulus, then there isn’t much for investors to get excited about or anticipate, or therefore, buy into in the third year. As we saw in 2011, we had nothing but roadblocks thrown in the way of the President by the split Congress. Really, one could say no stimulus was enacted that could bear fruit in the fourth year that would make voters feel good and get investors to buy into in the third year.
So if history repeats itself, and again there’s no guarantee that it will, it implies that maybe this presidential election year won’t be much to write home about because there was nothing to get excited about from the start.
EQ: The S&P 500’s price performance seems to have predictive powers on picking the next president. Can you talk about that?
Stovall: It actually has nothing to do with January or the full-year performance. It just says the market is, again, an early warning signal. The idea is based on the S&P 500’s performance during the three-month stretch of August, September and October of an election year. If the market is up, then historically, the party in power gets re-elected. If, however, the market is down during that three-month stretch, more likely than not the party will be replaced. The track record, again, has been quite enviable.
So whenever the market has been higher, it has been correct 88 percent of the time going back to 1948, basically indicating that investors are positive on what’s going on with the economy so they want to bring the same people back. However, when the market has been lower in that three-month stretch, then interestingly enough, the party was replaced 86 percent of the time.
In 1956, it failed to be predict correctly because the market fell by more than 7 percent in that three month period, even though President Dwight D. Eisenhower was re-elected. That was because we had the Suez Canal incident, which scared many people on a global basis, and also President Eisenhower experienced a heart attack, which shook investors. But since everyone still “Liked Ike,” he was re-elected.
The other time when the indicator failed was in 1968 when the market rose, implying that the Democrats would probably stay in power since President Lyndon B. Johnson was already in office. But when all was said and done, Hubert H. Humphries, the hand-picked successor of President Johnson, was not “pleased as punch”–as he liked to say–because Richard Nixon ended up winning the White House.
EQ: What are some sectors that investors may want to track more closely or avoid during election years?
Stovall: The interesting thing is that going back to the early 1970s for election years in general, the three best-performing sectors have been Energy, Consumer Staples and Financials. While the S&P 500 gained an average 5.9 percent in these presidential election years, the S&P 500 Energy sector rose an average 15.7 percent, Consumers Staples was up 10.2 percent, and Financials were up 9.8 percent.
Meanwhile, the worst performing groups were Information Technology, up only 0.9 percent; Materials, up 0.7 percent; and Telecom Services, down 6.1 percent.
However, I would say to take this data with a grain of salt because the sectors that do well or poorly are probably more closely tied to whatever the campaign issues happen to be during each presidential election. For instance, Healthcare in 1992 was a very big issue, as well as Energy being a very big issue both times the second George Bush ran for president. Also, I would say infrastructure spending was important during President Obama’s campaign. So each election has its own industrial hotspots to focus on, but it is still intriguing that some sectors have had a more consistent winning or losing record as related to election years.