How the Presidential Term Affects the Market

One thing I’m definitely seeing in this market is a reduction in the amount of attractive new investment opportunities. Last year was amazing for finding solid, profitable special situation investments.

So far this year, however, I’ve only been able to discover a few exciting new picks.

I’ve always contended that great investment opportunities in the stock market tend to occur in waves. This isn’t a scientific analysis, only an observation after many years of following the markets.

I’m quite sure that this year is going to continue to be difficult for the broader stock market. 2006 was a great year for stocks, especially large-cap stocks. This year, the stock market’s going to take a rest.

Here’s an interesting bit of research for you. Jeremy Grantham is chairman of Grantham, Mayo, Van Otterloo & Co. in Boston. This money management firm has more than $66 billion in assets.

Mr. Grantham has done a lot of research on the stock market, and he is now a believer in election results affecting the stock market.

His research, which looked at data from 1932 to 2003, indicates that stock market returns in the first and second year of a president’s term tend to be poor and frequently provide negative returns. Year three, however, tends to provide the strongest returns, with almost a 10% advantage above the average for the S&P 500. Finally, the fourth year is highly correlated to just average returns for the stock market.

Mr. Grantham’s research also shows that speculative, high-risk

stocks (defined as the top quarter of stocks with the highest volatility) have a high correlation to the presidential cycle. According to his data, this group of stocks tends to lose money for investors in the first two years of a presidential term, then provides an average return of some 30% in year three.

Mr. Grantham’s conclusion is that year three of a president’s term is eight times more likely to be positive than negative. But, considering the strong performance of stocks in 2006, perhaps the cycle is just a little ahead of itself.

Regardless, it will be very interesting to see how the stock market performs after the next presidential election.