War and the Presidential Cycle

The third year of the presidential cycle usually sees a strong market. Does war change the pattern?

By Joseph Lisanti

Although it's hard to tell by looking at the stock market, the economy is not doing too badly. With monetary stimulus in place and fiscal stimulus on the way, we expect the U.S. economy to show improvement as the year unfolds.

Yet, the economy is far from the thoughts of most investors, in light of the potential clash with Iraq. The anticipation of an armed conflict with Baghdad has left investors with little appetite for investment risk now.

This is the third year of President George W. Bush's term. Traditionally, the third year in the presidential cycle is the strongest as elected officials (both the President and Congress) try to boost the economy to improve their chances of re-election. Since 1946, the third year of the presidential cycle has seen the S&P 500 post an average gain of 17.4%, far in excess of the average gains of 3.6%, 4.3% and 8.6% seen in the first, second and fourth years of the cycle, respectively.

But with war apparently imminent, can the third year of the presidential cycle still be a good one for stocks? To find out, we looked at the performance of the S&P 500 since 1946 in those third years of a presidential term when U.S. troops were involved in a war.

The wars and years in question are the Korean War (1951), Vietnam War (1967 and 1971) and Gulf War (1991). On average, the "500" gained 18.4% in these years -- somewhat better than the overall track record in third years of presidential cycles. The average masks a large variation in results, ranging from a gain of 26.3% in the year of the short-lived Gulf War to a rise of 10.8% in 1971 when the public was growing weary of the endless morass of Vietnam.

Since 1946, in every third year of a presidential cycle when the U.S. was at war, the stock market rose. Keep 65% of investment assets in equities.

Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook

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