How Will the Election Year Impact Your Portfolio?

Many investors miss a powerful pattern tied to a regular phenomenon: US presidential terms. Here’s the S&P 500’s average return in each year of a president’s term:

• Year 1: 8.1%
• Year 2: 8.9%
• Year 3: 19.3%
• Year 4: 10.9%

The following illustrates Fisher Investments’ Presidential Term Anomaly and how markets have behaved over time relative to presidential cycles. Below is more perspective on why this happens.

Why are return averages higher in the second half? Legislative risk aversion is often much lower. Presidents typically lose relative power at mid-term elections. They know this, and push for more major legislation in the front half when their power is likely to be greater. You can see this in history—more material legislation has passed in the front half of presidential terms, rather than the back.

New legislation typically results in redistribution of money or property rights, or regulatory changes. Research shows people hate losses much more than they like gains, so when the likelihood of legislation is higher, overall risk aversion rises.Thus returns in years one and two are more variable with worse averages. But in the back half, when major legislation is less likely, returns have been more uniformly positive with better averages. This doesn’t mean investors should be automatically bearish in years one and two and bullish in the back half—many other factors influence returns. But legislative risk aversion is a material driver investors should consider.

2012 will be an election year—year four—typically a good year for stocks. However, in 2012, we either re-elect a Democrat or newly elect a Republican—history shows either is particularly a sweet spot for stocks. Stocks have averaged 14.5% historically election years a Democrat is re-elected, and 18.8% when a Republican is newly elected.