This yr, 2023, is the announced third yr of the presidential election cycle. It began with nervous markets watching the political drama in Washington, DC: contentious votes to elect the Speaker of the House of Representatives, a combative State of the Union address by the President, partisan threats not to lift the country’s debt ceiling, and the stance and positioning of the Lawmakers ahead of the 2024 election. Still, this third yr of the four-year cycle is anticipated to generate significantly above-average stock returns, in keeping with the presidential election cycle theory, first referenced within the U.S. presidential campaign.
So what are the strengths, limitations, and nuances of presidential election cycle theory and what does it accomplish? The current political context suggests this whether 2023 will follow the forecast trend?
The traditional narrative of election cycle theory and why it bodes well for 2023 is that this: “Presidents do the heavy lifting in their first and second years in office, then prepare for re-election in their fourth year by being market-friendly.” in third yr.” While the relevant data could also be compelling, the general narrative requires some refinement.
The Presidential Election Cycle and S&P 500 Returns
Source: Bloomberg
Since 1928, the third yr of the presidential cycle has produced positive S&P 500 returns 78% of the time, for a median return of 13.5% versus a full-year average of seven.7%. We didn’t find every other consistent indicators within the monetary and financial policy signals – for instance, a rising vs. falling rate of interest environment – that might also make clear 2023, but we imagine that a celebration’s degree of presidency control is an important factor could possibly be. In the primary and second years of the cycle, a single party held the “trifecta” of the presidency and House and Senate majorities two-thirds of the time, as Democrats did in 2021 and 2022, but only a couple of third of the time Time within the third and fourth years.
This is a well known phenomenon in US politics: the president’s party often suffers setbacks within the midterm elections. But it also implies that the relevant election cycle could also be a congressional slightly than a presidential election cycle. The markets may simply be rewarding the standstill. The third years following the transition from unified to divided government averaged 15.0% returns, in comparison with 10.7% within the third years that retained the trifecta. Given the likely contrast between the ambitious legislative agenda for 2022 and fears of possible gridlock in 2023, the query of gridlock seems necessary.
The order may be necessary in predicting how the presidential election cycle theory will play out in 2023. With their outlook half full, commentators are likely to concentrate on above-average returns within the third yr and pay less attention to below-average returns this second. The second years accounted for greater than a 3rd of the S&P 500’s total negative return years since 1928 and an excellent larger share of years with significantly negative returns or those, like 2022, that performed worse than -10%. The recovery pattern from bearish second yr to bullish third yr is the important thing sequencing feature. Since 1928, there have been two consecutive failure years only eight times, and just once, in 1930 and 1931, in the course of the Great Depression, did it occur within the second or third yr. Therefore, the signal for the second to 3rd years could possibly be particularly meaningful and predictive after such a dismal 2022.
Therefore, all of the leading indicators of the presidential election cycle theory – third yr, divided government and dismal second yr – appear to bode well for 2023. But are there current conditions that might affect this forecast strength? Put simply, even when markets respond well to the shutdown, an entire collapse of presidency operations could possibly be a bridge too far.
While fiscal restraint in 2023 could have its advantages after the federal government’s significant largesse in 2022, complete government paralysis and dysfunction – without raising the debt ceiling and without funding the federal government – could possibly be an excessive amount of for the markets and the economy.
Of course, debates over the debt ceiling are nothing recent in US politics and haven’t yet resulted in catastrophe. But simply because they have not done it does not imply they will not. So is it different this time? If that is the case, a selected congressional cohort could possibly be the edge reason.
In the closely divided House of Representatives, with its narrow Republican majority, the House Freedom Caucus wields significant influence and might obstruct laws to each limit government space and reduce spending. These efforts can even have a performative element, helping caucus members raise their profiles, campaign funds, and otherwise construct their brands. This latter component is maybe what most distinguishes 2023 from previous third years within the presidential election cycle.
In 2023, as in 2011 and 2013, the trail of political drama to economic significance runs directly through the debt ceiling and federal budget negotiations. The House Freedom Caucus has positioned itself as a key power base on this regard, making significant concessions in efforts to elect Rep. Kevin McCarthy as House Speaker. Among the more significant of those were securing the resignation of a single member and winning several of the Republicans’ nine seats on the 13-seat Rules Committee. This represents an efficient blocking position or veto, making it very difficult to pass laws raising the debt ceiling without the group’s approval or acquiescence.
There are few examples in recent political history of comparable groups gaining such influence. The difference is how performative Congressional politics has change into today. Given the rise of social media and a number of other politically centrifugal forces, the edge for differentiation has continued to rise, particularly within the lead-up to and aftermath of the 2020 election.
To understand how this performative power might need change into a differentiating think about the third yr of this presidential cycle, it helps to conduct a memory experiment. Think about 10 members of Congress. How lots of them do you remember based on their achievements? How many do you remember for his or her transgressions, disabilities, or histrionics? This explains the danger that successful (not only threatening) confrontations and disruptions can change into self-reinforcing phenomena. Or what happens when neither side blinks in an ever-escalating, high-stakes game?
Of course, there’s something counter to all of this, and that’s the essential reason why 2023 could live as much as expectations and deliver strong returns. The debt ceiling drama is just that, a drama – performance as friction, but without the likelihood of causing lasting damage. The markets can have some scary moments, however the United States will eventually pay its bills. Turbulence is not any fun when flying, however the plane still lands safely.
Several possible steps could help avoid a debt ceiling impasse. We expect to listen to more concerning the concept of a “relief request” and assume that an eventual suspension, although perhaps not an explicit increase within the debt ceiling, can be a market acceptable conclusion. The volatility along the way in which may grab the headlines, but there may be the underlying and broadly stabilizing force as a tortuous spring of 2022 stimulus packages are passed in 2022 – the Infrastructure Act, the CHIPS Act and the Inflation Reduction Act or ” Build Back Better.” For each of those programs, 2022 can have been the metaphorical architecture phase, while 2023 begins the development phase, which, all else being equal, should increase nominal activity, jobs and spending.
The heuristics due to this fact provide some necessary insights. Still, risks could peak ahead of the budget financing deadline at the tip of September, assuming so-called extraordinary measures to forestall the debt ceiling from being exceeded might be prolonged until then. So it might be price heeding one other heuristic like this – watch out for early fall.
You will find more information on this topic here Michael Edwards’ podcast on the idea of the 2023 presidential election cycle.
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