How Stocks Could Fare Over Trump's Next Two Years

The following is a reprint of the market commentary from the December 2018 edition of The Option Advisor, published on November 16. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- visit our online store.

While the final results are still being tallied in some areas, as of this writing, the hotly contested midterm elections are largely behind us. And that should be welcome news for investors, as we're now moving into the third year of the presidential election cycle, which has historically been the strongest for the stock market.

So far, the Trump presidency has acquitted itself quite well in terms of stock market returns. The first table below shows the S&P 500 Index (SPX) returns for each four-year presidential term since Hoover, broken down by halves -- the first two years of the cycle, and then the second two years of the cycle (taken together and annualized). Among the 23 presidential terms since 1928, Trump's "first two years" return of 31.2% ranks fifth behind Clinton (second term), Reagan (second term), Obama (second term), and Eisenhower (first term).

Of that group mentioned above, only Eisenhower went on to top his impressive "first half" stats in the second half of the presidential cycle, as the S&P surged 43.1% over the final two years of his first term (19.6% annualized). On the other end of the spectrum was Obama, as the S&P was virtually flat toward the end of his tenure in office -- adding just 2.7% during the second half of his second term, or 1.3% annualized.

But typically, the last two years of a four-year election cycle are more bullish than the first two -- and the third especially so, as noted above. Per the table below, the last two years outperform the first two across a number of metrics, with the average return for the second half nearly tripling that of the first half. The median return, percentage of positive returns, and average positive return are also significantly higher.

That said, note that the average negative return for the last two years of a presidential cycle is a loss of 34.61%, compared to a 20.64% drop for the first two years of the cycle. Likewise, the standard deviation of returns is greater, at 30.29% vs. 25.94%. So while the odds lean in favor of a big bullish bias over the next two years of the Trump presidency, the negative returns in these scenarios have a tendency to be steeper than usual, with a somewhat higher degree of volatility.

The tables below show how the final two years of the cycle tend to play out based on the S&P's performance during the first two years of the cycle. It's relatively rare for the first half of the cycle to generate returns in excess of 25%, as we've seen during this cycle, so the sample size is comparatively small. However, in past instances when the first two years have been this resoundingly bullish for the S&P, the returns over the next two years have been 100% positive.

The average return over the second half of these cycles is 35.03%, with a median return of 25.85% -- outperforming the comparable returns in the 18% range for those cycles where the first half has been bullish to a more modest degree. On an annualized basis, that shakes out to an average return of 15.48%, and a median return of 12.18%.

Again, though, note that final row of data, where the standard deviation of returns is displayed. After a "blowout bullish" first two years, the standard deviation of returns over the next two years is 34.85% -- considerably higher than 24.45% when the S&P gains between 0% and 25% in the first two years, and even a notch steeper than the 34.52% registered after a negative first two years.

On balance, the takeaway seems to be that history points to more upside out of the S&P over the next two years until the 2020 election. But rather than a slow, steady uptrend, investors might want to prepare for a continuation of the high-octane volatility that has characterized the stock market action since the start of October.