Written in the Polls

A crystal ball won't help you predict where the stock market is going, but the 2008 election may.

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By Scott Bernard Nelson

There are all sorts of theories about how to predict the direction of the stock market. Some of the nuttier, yet oddly memorable, theories are based on the Super Bowl (victory by an original NFL team is bullish) and women's fashion (invest long if the hemlines are short). Inspired by these seemingly goofy premises and the fact that 2008 is just around the corner, I recently asked the number-crunchers at Ibbotson Associates to take a look at past election years to see if a telltale pattern emerged in stock market behavior. Somewhat to my surprise, it did. Ibbotson's chief economist, Michele Gambera, sounded similarly surprised after looking at his research department's numbers. "While we haven't run statistical tests, I would say it is a material difference," he said.

What constitutes "material"? In this case, Ibbotson looked at presidential election years back to 1928, comparing them to nonelection years over the same period. The S&P 500 averaged 12.6 percent during election years and 9.7 percent during nonelection years. Even if you toss out 1928—a bubble year in which the index posted a 43.6 percent return—election years still trounce nonelection years by almost 3 percentage points per year. With 81 years in the sample, including 20 elections, the results seem like more than just a statistical fluke. "The presidential cycle in market returns is, as it turns out, significant," Gambera said several days after Ibbotson ran the numbers. "They actually find it in economic research."

But even if you accept that presidential election years are historically positive for the financial markets, it's hard to know why. Maybe incumbents in the White House and Congress grease the wheels of the economy a little more in those years. Maybe optimism tends to overwhelm business executives and investors. Maybe why isn't what's important.

The bigger question is, What are you supposed to do about it? The answer, as anticlimactic as it might be, is probably not much. There are so many hedge fund managers and day traders attempting to arbitrage any discrepancy in the financial markets that there's not much left for individual investors. Besides, identifying specific stocks that will do well next year isn't as easy as saying the S&P 500 is likely to do well. So while you ponder your vote in the months ahead, remember that long-term averages are on your side. Keep plowing money into your stock portfolio over time, and you will still be celebrating long after the Inaugural Ball.

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