The 2016 US Presidential Election - Not

Your Typical Year

Any major economic or political event in the US, especially one that is recurring,
is bound to be tested for its impact on the stock market.
And as far as big events go, there are few as big and closely followed as the US
Presidential elections.
Given the importance of the event, the Internets already abuzz with speculation.
There has always existed a fairly evident cyclicality between the stock markets
performance in the US and its four-year Presidential term.
While each presidential cycle would typically have its own set of unique
circumstances and economic indications, over the past 116 years (period
considered for analysis in this note) the latter part of a presidential term has been
favourable for stock prices. We observe that policy decisions necessary for
improved economic activity and growth typically occur during the first half of a
presidential term.

While the net impact of these decisions are meant to be positive, they could still
imply higher taxes, increased regulation, and tighter controls. As such, they may
not bode well for corporate profit expectations.
As a President approaches the latter part of his term, policies tend to favour the
electorate. Harsher measures are unlikely to be put in place. Of course, external
global factors would still play a role in determining which way the stock market
moves. A case in point is the recent global recession of 2008, where despite
being the last year of a US presidency, the Dow Jones lost 34% of its value led
by the sub-prime crisis and a near freeze on global financial markets.
Having stated the average US stock market behaviour driven by the US
presidential cycle, we believe the 2016 election year would break away from the
trend. While there are a few noteworthy common traits that suggest 2016
shouldnt stray from the norm, there are some clear emerging trends that, in our
view, could defy it.

The Two Sides of the US Political System

Before we illustrate our findings, heres an overview of the US political system
with respects to its two oldest parties, i.e. the Democratic Party (est. 1828) and
the Republican Party (est. 1854).
Since the beginning of the 20th century, both parties have shared the presidency
almost equally, 15 for the Republicans and 14 for the Democrats.

Policy-wise and on key issues, both parties differ markedly.

While Democrats are more liberal and progressive, the Republicans tow a
conservative and traditionalistic line.
Here is how they compare on some of the most debated issues in the US.

Both parties have been diametrically opposite on some very contentious issues
in recent US political and economic debates however, some of which include
calls for tighter gun control after a spate of civilian gun shooting incidents, issues
related to immigration especially with the mass exodus of Syrian refugees
currently taking place in the Middle East, and government spending on
healthcare. Looking at the above comparison, one can understand the strong
rhetoric used by the current Republican hopeful Donald Trump with respect to
gun control and immigration.
Some of the more prominent candidates for the nomination of the 2016 US
Presidential election include Donald Trump, Ted Cruz, and Marco Rubio from the
Republican Party. The Democrats have Bernie Sanders and former First Lady
and Secretary of State Hillary Clinton as two of their main candidates.

Presidential Terms and the US Stock Markets

Cyclicality
Coming back to the impact of a Presidential term on the stock markets, our
empirical analysis backs the view that historically the second half of the
four year period has been stronger on average.

The Dow Jones Industrial Average has returned, on average, nearly 12% and 7%
in Year 3 and Year 4 respectively over the past 29 Presidential terms. The
economy has also performed comparatively better on average in that period,
which, in our view, reflects the impact of the measures that the governments
usually put in place during the first half. Its also worth noting that, historically, a
majority of corporate tax increases have occurred during the first half, while a
majority of the corporate tax cuts have occurred during the second half.

Another interesting anecdote to note is that the US stock market, in an election

year, has gained (on average) its highest when the incumbent President is not
running for a re-election. This is the case in 2016, with the current President

Barack Obama having already served his second consecutive term at the White
House.

Heres Why 2016 Wont Be a Typical Election Year

for the US Markets
While there are a few historical trends that suggest why 2016 could differ from
the usual cycle, there are some new and emerging trends that appear more
convincing. But first, lets see what history has taught us.
Historically, the US stock market (on average) has underperformed by over 900
bps in an election year when a Democrat is in the White House as compared to
when a Republican is an incumbent.
We also note the effect of the January cycle. It has been widely prescribed that
the US stock markets performance in the month of January is a very strong
indicator of how the rest of the year pans out. We extrapolate this hypothesis
onto election years over the past 116 years and note that out of the last 28
Presidential cycles, there have been 14 instances where the DJIA saw a decline
in January of which 65% of the times, the full-year returns were also negative.

The year 2016 saw the DJIA fall by over 5% in the month of January. Over the
past 115 years, over 60% of the time, Januarys performance has been an
accurate indicator of how the entire year would settle.

The World Is a Different Playground Now

While weve noticed a few trends in history that suggest 2016 will defy the norm,
the fundamentally different global economic scenario that the current election
year is encountering could make a huge difference.
The biggest game changing factor of all, in our opinion, is China.
The Asian economy now contributes almost 16% to global GDP and is the
second largest in the world. US trade deficit with China has increased nearly 5x
over the past decade and a half alone. Therefore, Chinas rapid economic
slowdown is likely to build pressure in 2016.

The current oil price dynamic also has no precedent.

Oil prices have lost almost 70% of their value since the mid-2014. As much as
the tepid global economic growth scenario has a role to play, the ongoing geopolitical crisis has exacerbated the fall. Some might argue that $30/barrel is
pretty much the floor; volatility on the way up could still keep US markets on the
edge in 2016. Only three times in last 116 years has the price of oil dropped as
much or more in the year preceding an election year.
Finally, the US dollar has seen significant gains in the past 12-15 months and
could also put some pressure on overall economic growth in the US. A strong
American Dollar makes US goods more expensive in foreign markets, leading to
a negative impact on the US overall trade balance. 2016 could also see a much
more definitive move up in the Fed fund rates, putting further pressure on US
equities.

We also note that 2015 saw the dollar index increase by almost 10%, among the
highest gains any year has seen going into the election year. Our analysis
suggests that over the past 50 years, the dollar index and the Dow Jones
Industrial Average have an inverse correlation of 48% suggesting that a
strengthening dollar, going into 2016, has a good chance of keeping the equity
market under check.
Valuation doesnt seem to be in favour of the US equity market either.
The S&P 500, adjusted for inflation and cyclicality, is trading at near all-time high
levels, excluding the technology bubble seen at the start of the last decade.

We, therefore, believe it would be unwise to position ones portfolio towards US

equities purely on the basis of the US markets cyclicality with Presidential
election years. There are clearly more than a few factors that are likely to be
headwinds for the market. The ongoing Presidential campaigns and debates too
have been rather vague and uninspiring, leading to more scepticism. We believe
US safe haven tag and lack of alternatives for equity investments elsewhere
globally are the two key factors that are likely to extend support to the market.

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