Why Year 3 of Trump Could Be Bullish

Bearish sentiment could mean upside for stocks in year three of Trump

Senior Quantitative Analyst
Jan 16, 2019 at 7:08 AM
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The third year of a presidential cycle is well-known to be bullish for stocks. I’m not sure it’s wise to expect anything typical from this administration, but below I’ll be looking at the historical numbers. There are a few theories as to why the third year would be so good for stocks. Maybe investor confidence grows when the new Congress begins. Another possibility is that presidents begin eyeing the next election in their third year and promote market friendly policies to boost their chances.

Of course, it’s also possible that it’s simply random and that’s just the way it has turned out. Whatever the reason, the stock market performance over the last 70 years in a president's third year is quite impressive.

Third Year of Presidential Cycles

The table below summarizes the yearly returns on the S&P 500 Index (SPX) for each of the presidential cycle years going back to 1949. The average return in the third year of the cycle is 16%, which trounces any of the other years. The other years all average around six and seven percent. Out of the 17 cycles, the third year was negative just two times. Those two times, however, were the last two cycles. The S&P 500 lost 0.7% in 2015 and 0.003% in 2011. So, in the two down years the index lost less than 1%.

spx presidential cycle 1

The chart below emphasizes how much more bullish the third year has been compared to the others. It shows the average S&P 500 return path for each cycle year. The third-year average return blows away the other years right off the bat and never looks back. On average, the index has been up double digits before May.

years of prez cycle 2

If you buy the third-year narrative based on the historical data, then now is the time to get in. More specifically, it’s been the first half of the year when most of the gains occur. In 17 presidential cycles, the first half of the third year has yet to be negative.

spx since 49 3

Third Years with Bearish Sentiment

Finally, there’s one more bullish indicator to consider. Last week, I wrote about the Investors Intelligence survey showing market newsletters were more likely to be bearish on stocks than bullish. Look at how the previous years fared when the third year of a cycle began with such negative sentiment from this poll. Each of the four previous occurrences saw yearly double-digit returns. Three of the four years were up more than 20%. The data is bullish even by third-year-of-the-cycle standards.

third year sentiment 4

 

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