we reprint nick dewhirst's first article for international investment - on the US election four year's ago - and find nothing has changed
The US presidential cliffhanger kept us occupied for most of November. After the last six elections, Wall Street performed better by 11% under a Republican incumbent over the four-year cycle but it was the post-election year that made the real difference, with improvements as much as 16%. That Republicans are better for the stock market is confirmed by the long-term statistics: 5% outperformance per cycle on average over the past 40 elections.
Buy at the mid-term and sell at the full-term elections is an old Wall Street adage, but is it still valid? Should investors be selling out of Wall Street now that there has just been another presidential election?
This adage worked for 150 years until the middle of the 1970s (see table). Since then, share prices have risen regardless of the stage in the cycle.
Does this mean that the old adage is to be discarded along with many other long-established investment strategies and that new rules apply for a new economy? I think not.
Firstly, one should bear in mind that, since 1974, share prices on Wall Street have risen approximately 2,000%. Such a powerful long-term up-trend can mask many an underlying cycle and delude investors that basic laws of investment physics have been abolished, when they have merely been suspended.
In this case, the relevant law is that of the Pork Cycle, named after the long tradition of pork-barrel politics in the US, and based on the premise that actions in one period have side-effects only in later periods, which in turn require the initial action be reversed. For this stock market cycle, these are pre-election promises and post-election disappointments.
Specifically, the costs of a pre-election consumer boom are paid with post-election inflation, high interest rates, over-capacity, and collapsing profits. The tactics may vary from one cycle to the next, but the game remains the same, and does so for the solid reason that peace is the only vote winner bigger than prosperity.
Coser study of the table shows the underlying cycle remains intact, if one looks at performance relative to trend. Then the figures for the respective years change to -4%, -2%, +4% and +2% over the very long term and to 0%, -4%, +6% and -2% during the last quarter century. In both periods, the better half was the second, and the best period was the year immediately following the mid-term elections.
The second chart of cumulative monthly performance averaged over the last six cycles shows other interesting features. Here the greatest negative divergence from trend appears in month 23 after the full-term election, the month immediately preceding mid-term elections.
The cycle's persistence can also be seen when studying the global context. What is true of the US, applies elsewhere. Our analysis of election cycles shows that four years is the duration for countries accounting for 75% of global GDP and 78% of world market capitalisation, including Japan and Germany. The UK five-year cycle is an anomaly.
It is likely that similar pressures around the world act to exaggerate the cycle. Indeed, while our Rest of World (Row) average performs in a steadier manner, it nevertheless displays similar short-term fluctuations.
On average, Row beats the US by 10% in the first half and gives back 5% in the second half of each cycle. Many a fund manager would be proud to beat their benchmark by such an amount. If past patterns persist, investors with switching facilities in life and pension funds could achieve that with just two transactions every four years.
Should the new millennium herald a new era of investing, it may be that markets cease to skyrocket but return to earth, as gravity re-exerts itself. If so, the fashionable buy-and-hold strategy would become old hat, and investors will have to work for their profits again, exploiting cyclical swings in asset classes to maximise gains.
History repeats itself
This is what I wrote four years ago in the first feature I contributed to Investment International. The chart from that December 2000 issue has been updated and an extra row included in the table comparing the current cycle to both the ultra-long-term and the modern era. Year by year the last cycle performed as predicted by the theory. Year one was bad. Year two was worse. Year three was best. Year four was good.
The past cycle saw a return to cyclicality. The new Millennium proved to be the peak of the two-decade long secular bull market. The surprise was not that bear markets reappeared worldwide, but that they were so severe. From start to finish, US share prices fell 11%. Only the 18% decline over the 1972-1976 cycle was worse. That was dominated by the first oil crisis, soaring inflation and price controls.
However, Row performed marginally better in local currencies and much better when adjusted for the decline in the dollar. Elsewhere in the world, shares in contrast rose by 9%, thereby out-performing the US by 19%. Virtually all this outperformance took place in the second half of the cycle, when the declining dollar took its toll.
As to the outlook for the coming cycle, I see good reason to repeat the prediction of a strategy with a successful century-long tradition. For the first two years of this presidential cycle, US shares are likely to underperform both their international peers and their own long-term average performance.
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