Not Your Typical Pre-Election Year For The Stock Market

It is widely known that the third year in the 4 year election year cycle is very good for the stock market – on average. That qualifier is going to be important to stress this year as the historical pattern seems to be breaking down.

Until the start of this month, the Dow Jones was on the same historically set path as always. It was even a bit ahead of itself earlier in February. But with the recent market weakness, the Dow Jones has veered off the average historical precedent and basically wiped out any gains for the year:

Source: Chart of the Day

I mentioned a caveat for the presidential year cycle a few weeks ago: When the Presidential Cycle Backfires. To summarize, if we separate the instances between when an incumbent was re-elected and when they lost to another candidate, the 3rd year looks completely different. For charts and full details, follow the previous link.

No longer is the third year the charming, happy-go-lucky year for equities. I think it is too early to conclude this for 2011 but for now, it is important to remember that this pattern is only an average and that if the economy weakens, due to an oil shock or other external influences, most probably we’ll see a new president for the US. And that means that the stock market will have performed quite poorly as well.

The third year cycle is an important reason for many people being bullish right now. This includes illustrious investors like Jeremy Grantham of GMO who expects the market to continue rallying until the cycle ends in September-October 2011 (see “Pavlov’s Bulls”). But if we look a bit deeper at the actual data, this is anything but a slamdunk.

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