Some stock market watchers are quick to dismiss correlations to election cycles as spurious.
However, there are some notable patterns that emerge based on the four-year US election cycle that very much tie elections, economics, and market together.
"As always, past performance is only an incomplete indication of future performance," wrote Goldman Sachs' Jose Ursua in a note to clients. "But certain patterns, especially those that pass a reasonable number of statistical tests, can be useful guides to surfing the electoral wave ahead."
Ursua listed three reasons why investors should take these cycles seriously:
Elections are important market events, for at least three reasons. First, the political stakes in presidential, parliamentary or legislative elections often translate into changes in policies which can reshape the economic environment. Second, the regularity with which elections take place in most countries may give place to cyclical patterns in government and investment behaviour. Third, elections can markedly increase political and social uncertainty. These three factors have the potential to affect all asset classes, especially equities, given their strong sensitivity to changes in the economic outlook.
Here's a quick summary of his findings:
Our results suggest that, in the US, the first two years of the election cycle tend to coincide with lower equity returns than the last two, with the second year particularly volatile. In the run-up to elections, returns tend to move sideways as a reflection of unresolved uncertainty. As uncertainty fades, returns tend to bounce back gradually. We also find that global equity markets tend to reflect the US election cycle, with lower returns in the second year of the cycle and declining volatility thereafter. In particular, the election cycle in the US helps to explain a sizeable fraction of non-US equity returns, both in other developed markets and in emerging markets.
Much of this is well-known.
However, the bit about U.S. elections explaining non-U.S. equity returns is quite interesting. Ursua provides this chart of R-square results derived from his equity returns regression analysis. For U.S., developed markets, and emerging markets, equity market returns seem to be much better explained when considering U.S. election-related variables.
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