The Presidential Phenomenon That Could Impact Stocks in Q4

The last three months of the year are typically the most bullish for U.S. stocks

Oct 3, 2017 at 2:22 PM
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The fourth quarter is typically the strongest of the year for U.S. stocks. However, while the Dow Jones Industrial Average (DJIA), S&P 500 Index (SPX), Nasdaq Composite (IXIC), and Russell 2000 Index (RUT) typically outperform in the final three months of the calendar year, 2017 could be an exception for some of the indexes, if history repeats. Below, we'll take a look at how the record-setting Dow, S&P, Nasdaq, and RUT could fare during the tail-end of President Trump's first year, and why volatility could ramp up heading into 2018.

For the Dow and S&P 500 Index, Schaeffer's Senior Quantitative Analyst Rocky White looked at data going back to 1937, since that's the first presidential inauguration that took place in mid-January. As you can see below, the fourth quarter is typically the strongest for both indexes, with the Dow and S&P averaging a gain of 3.31% and 3.35%, respectively. That's more than five times their average third-quarter returns. What's more, the indexes boast respective win rates of 73.8% and 75% in the fourth quarter -- much higher than any other.

Dow by quarter since 1937

SPX by quarter since 1937

However, as alluded to earlier, the first year of a presidential cycle tends to rain on stocks' fourth-quarter parade. In these years, the Dow has averaged a slimmer-than-usual return of 1.88%, with just a 65% win rate. The S&P, meanwhile, has averaged a fourth-quarter gain of 1.49% -- not even half its typical fourth-quarter gain -- and was higher 70% of the time. Plus, volatility is much higher than usual during these periods, as evidenced by the indexes' standard deviations.

Dow Q4 presidential cycle

SPX Q4 presidential cycle

But this phenomenon has been somewhat limited to blue chips and big-cap stocks. The Nasdaq and the Russell 2000 -- barometer for tech and small-cap stocks, respectively -- have actually fared even better than usual during the fourth quarter of a president's first year in office.

Going back to 1971 for the Nasdaq (the first year we have data), the index has averaged a fourth-quarter gain of 4.45%, with nearly 70% positive -- the highest of all. Looking at RUT since 1979 (the first year we have data), the index has averaged a fourth-quarter gain of 4.38% -- compared to an average third-quarter loss -- and was higher 73.7% of the time.

Nasdaq by quarter since 1971

RUT by quarter since 1979

During the first year of a president's term, the Nasdaq has averaged an even higher-than-usual gain of 4.85% in the fourth quarter, with a healthy win rate of 72.7%. And volatility is actually lower than usual for the IXIC, with a standard deviation of 12.36%, compared to 13.96% normally.

The RUT boasts an average fourth-quarter gain of 5.63% during the first year of a president's term -- more than a full percentage point above the norm. And the RUT sports a win rate of 77.8% during these quarters, with lower-than-usual volatility, as measured by the index's standard deviation stats.

Nasdaq Q4 presidential cycle

RUT Q4 presidential cycle

In conclusion, if past is prologue, speculators may want to consider Nasdaq stocks or a few small-cap stocks for short-term bullish plays, as the IXIC and RUT tend to outperform even their typically healthy fourth-quarter gains during the first year of a presidential cycle, while the collective light for the Dow and S&P tends to dim during these years. However, looking ahead, you can see on the charts above that the fourth quarter of 2018 -- the second year of a presidential cycle -- could be about the best time to invest in stocks of any color, if history repeats.

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