US stocks have historically performed better in the second half of a presidential term than the first half. Also, there has been more variance in stocks performance in the first half of a presidential term than the second half.
The third year of a presidential term has historically been the best performing year for stocks.
Why is that?
First keep in mind the best opportunity to pass landmark legislation is in the first two years of a presidential term. In almost every case the president’s party loses power in the mid-term elections, and therefore loses the power to pass major legislation.
Now let’s think about the fourth year of a term, the election year. The president is trying to get re-elected or is trying to get his successor elected, and therefore will not try to pass any major legislation. The president’s party has (most likely) lost power in the mid-term elections to the opposition and therefore is not able to pass any major legislation. People of both political spectrums tend to be optimistic that their candidate will win the upcoming election. Summary of the fourth year, political gridlock/status quo, combined with a general feeling of optimism in both political spectrums. (Based on the polls, we do not have that optimism this year)
In the inaugural year of a term about 50% of the country is dissatisfied with the election results and is pessimistic. The other 50% of the country was really optimistic, but quickly becomes saddened to realize that the conservative or liberal that was elected is not nearly as conservative or liberal as they had hoped for. Also, as mentioned above the politicians are passing or talking about passing major legislation leading to uncertainty. Remember that legislation is some form of redistribution of money and/or property rights, and the markets do not like that.
The second year tends to be more of the same, perhaps without the degree of pessimism and/or gap between expectations and reality. Legislation is actually being passed. This means change and uncertainty, and redistribution. The markets do not tend to like those things.
Lastly, in the third year of the presidential term the president has lost power to pass major legislation because of the mid-term elections and the uncertainty of the upcoming election is still far enough away. This sets up for a perfect year of inaction, status quo, stalemate, whatever you want to call it; markets tend to like it.
Always keep in mind that politics is only one of a myriad of market drivers, and investment maneuvers should never be based solely on the political environment.
I am consistently mystified by the media attention given to figures like Kim Kardashian. Why and how does this happen?
I have similar feelings when I see the reporting on the Dow Jones Industrial Average (or the DJIA, or simply the Dow). Way too much attention is paid to the Dow. Whether it is in the media or amongst laypeople, it seems everyone loves to talk about the level of the Dow or how many points it moved as if it is indicative of anything.
Paying attention to the Dow is kind of like following what is happening with Kim Kardashian, it is an interesting curiosity and diversion, but hard to put into context what the real relevance is. The Dow is an extremely narrow index of stocks (only 30 firms, all US) and it is “price weighted” making it a very poor representation of US stocks let alone the global stocks.
First let’s talk about the narrowness. As I mentioned before, the Dow is comprised of only 30 US firms. There are thousands of US stocks out there, and the Dow index only accounts for 30 of them. Granted they are really big companies, so at any given time the Dow may account for ~20% – 30% of the total value of US stocks. That’s not a very big representation of US stocks period, and it is especially poor when compared to the S&P 500 index which accounts for more than 80% of the total value of US stocks.
No investor should ever be fully invested in only one country, even if that country is one as big economically as the US. Investing globally is the easiest form of diversification, and the Dow is 100% US stocks.
The firms that make up the Dow are arbitrarily selected. Currently Apple (AAPL) and Microsoft (MSFT) are in the index, but Alphabet Inc. (that’s Google, GOOGL) isn’t in. JP Morgan (JPM) and Goldman Sachs (GS) are in the index, but Bank of America (BAC) and Wells Fargo (WFC) are out. Why? I couldn’t tell you, but I am sure if you do a little digging you can find some canned vague explanation for why the index holds one stock vs. another.
Lastly the Dow is a “price weighted” index meaning that stocks with a higher share price are given more weight (influence) on the performance of the index. Using price weighting Goldman Sachs (GS) with a share price ~$160 has more than double the impact of Wal-Mart (WMT) with a share price of ~$70 even though Wal-Mart is almost three times the size.
Good stock market indices are weighted based on market capitalization (the size of the company).
The attention given to the Dow is overdone. The Dow should not be used as a benchmark for the individual investor, and it should not be viewed as a good representation of the markets, US markets, or even large-cap US stocks.
The stock market is a function of supply and demand. Now that we have covered that we can move on…. Whoa, hold your horses there cowboy. Yes, the markets are a function of supply and demand, but in my experience very few investors understand the mechanics of the above statement or the very powerful implications of it.
First let’s talk about the mechanics of supply and demand in the markets. In the short-term stock supply is relatively fixed. Initial public offerings (IPOs) and new stock issuances take a great deal of time and effort and are announced well in advance of the action occurring. Therefore over the next 12-18 months it is very hard for there to be big unexpected shifts in stock supply.Since supply is relatively fixed in the short-term, demand is the great driver of stock prices over short-term periods.Demand tends to change very rapidly and is verysentiment based.
Over the long-term supply curve pressures overpower demand curve pressures.Stock supply can expand or shrink boundlessly over the long-term. Supply is increased through issuances and shrinks through buybacks and cash or debt-based takeovers.
When demand for a category of stocks becomes very low and prices fall it leads to increased buybacks, mergers, and acquisitions which destroys supply and eventually will lead to higher prices. We saw this with the financial sector in 2008 & 2009, and have been witnessing it more recently within the energy sector.
Conversely when a category of stocks becomes in very high demand, usually because of recent strong performance, new supply will be added until it eventually dilutes future returns. We saw examples of this within the technology sector in the late 90s moving into the 2000 bear market and with the run up in emerging markets prior to the financial crisis.
Investment bankers make money by facilitating new stock issuances, buybacks, mergers, and acquisitions. Often times they are seen by the public as mysterious boogeymen, but their work enables the stock markets to be a very efficient function of supply and demand.
Understanding the principle of supply and demand as it relates to stock markets shouldhelp an investor to properly diversify their portfolioandavoid “chasing heat”(falling in love with a category of stocks because of recent strong performance).
