Just in time for the historically favorable fourth quarter (and ahead of an election year), the stock market has shifted character with the return of the bulls as we round out what has been a choppy, yet gratifying, year for equities. While the tech sector strongly outperformed in 2023, other areas of the market were more volatile, creating a classic stock picker’s market environment for much of the year.
A 10% correction in the S&P 500 Index between August and September was a cause of consternation for many investors, giving them a sense that another bear market was in the making. But for all the negativity surrounding the late-summer/early-fall months, by late November the S&P was up by a remarkably strong 21% year-to-date, while the Nasdaq Composite was up by an eye-popping 38%.
For those who follow the U.S. presidential cycle theory of stock market investing, the stock market’s strong showing for most of 2023 should come as no surprise. According to the basic premise of the cycle made famous by market statistician Yale Hirsch, the third year of a president’s tenure is typically the year that shows the strongest S&P performance of the entire four-year term of office.
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In fact, according to the research conducted by Yale and his grandson Jeffrey Hirsch in Stock Trader’s Almanac, the average S&P gain during year three of the presidential cycle over the last few decades is 16%. Granted that 2023 isn’t quite finished, but if the market’s performance to date is any indication, this year should exceed the long-term average.
What then can investors expect for the fourth and final year of the presidential cycle? According to the younger Hirsch, election years tend to be “mediocre on average” for the stock market and bordering on outright tumultuous in recent presidential election years, with 2000, 2004 and 2008 featuring a weak market environment during episodes that Hirsch described as “battleground” elections.
Confirming this is research by U.S. Bank’s wealth management arm, which found that S&P 500 data going back to the 1930s revealed that, on average, stock and bond markets “showed more muted performance in the year leading up to a presidential election than they did at other times.”
More specifically, Hirsch’s research found the average S&P gain during the final year of the four-year presidential cycle is a pedestrian 7%, which is below the 9% average return seen in non-election years. That’s not a bad return, but certainly nothing to brag about. And when compared with the average return of the prior year, it’s downright disappointing. That said, is there any reason to expect the stock market will outpace the historical average in 2024?
As it turns out, yes there is!
As we round out the third year of the presidential cycle, a dramatic shift in investors’ perceptions about inflation and the economic outlook is taking place—one that could alter the investment landscape for next year. For one, a growing number of participants believe the Federal Reserve is done raising interest rates and may even begin lowering them in 2024.
Last week, widely followed market strategist Ryan Detrick observed that “the Fed has likely stopped hiking, [which] will no longer be a headwind for equities going into next year.” And if the Fed drops the Fed Funds rate, as a growing number of strategists expect, it could act as a major catalyst for additional market strength. (On that score, investment bank UBS just published a client note suggesting the Fed “will shock markets with aggressive interest rate cuts next year,” with the central bank possibly cutting rates 275 basis points by the end of 2024.)
Detrick further believes that by avoiding a recession—which many economists have been predicting in recent months—the economy will no longer be an inhibiting factor for equities, thus removing a major impediment and making it easier for the bulls to consolidate and build upon their recent gains heading into 2024.
Moreover, Detrick noted that if you remove the admittedly expensive technology and communications sectors from the market (both of which tend to underperform in election years), “stocks are actually relatively cheap” from a fundamental perspective, which should provide an additional incentive for investors to buy following the recent correction.
Preparing Your Portfolio for an Election Year
In terms of how to structure your portfolio for the upcoming election year, U.S. Bank’s chief strategist Tom Hainlin noted that healthcare and energy are two sectors to avoid, as both tend to show heightened volatility during election season as the incoming president’s healthcare and energy policies will be implemented only if there are enough members of his own party to successfully legislate it. (Additionally, the latter sector tends to suffer from increased volatility due to the divergent opinions of both parties on the subject of “green” energy.)
By contrast, the utility sector has a tendency to outperform during a presidential election year due to the defensive nature of utility stocks. With so much uncertainty swirling around the election’s outcome in the months leading up to it, asset managers tend to hedge by overweighting utilities in their portfolios, thus boosting the sector’s historical performance in the presidential cycle’s final year.
Moreover, a research report by Goldman Sachs noted that the equally defensive consumer staples sector often outperforms during presidential election years and may be worth a closer look heading into 2024.
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