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How Stocks React in an Election Year - views
NEW YORK (Stockpickr) -- Over the past 100 years, a clear pattern has been in place. The stock market has tended to trade in a similar fashion in each of the four years of a presidential cycle -- that is to say, first-year results are similar from term to term, and so on. The logic behind such rational price action is quite simple: Presidential economic policies tend to follow predictable patterns that boost the chances a president (or his party) will stand a better chance of re-election.
As we head into the final year of the four-year cycle, what should investors expect? Well, the historical data suggest we’ll get a nice rally, although recent stock market activity seems to be held hostage to some unusual factors that are impacting this historical cycle.
The first year of a new term is usually characterized by policies that represent a break from a predecessor's policies, usually based on populist-oriented promises that were made during the campaign season. This "feel-good" environment has, on average, generated an 8.8% gain in the first year of a new presidential cycle, according to veteran Wall Street strategist Mark Hulbert. The “year” in question is actually Oct. 1 to Sept. 30, as that is the period in which investors tend to start thinking about the impact of a new regime.
Of course, the first year of President Obama’s term, 2009, was extremely unusual. The S&P 500 stood at 1160 at the end of September 2008, plunged by 900 by year’s end and kept falling all through the first six weeks of President Obama’s first term to 675. Yet the index managed to rebound to around 1050 by the end of September 2009. That 10% overall drop stood in contrast to a similar-sized projected gain.
A president’s second year is usually not very favorable, and the market has risen, on average just 0.4%. That’s when a president often looks to enact tougher policies that can often restrain growth, knowing that several years remain before voters will respond to the new set of policies. Year No. 2 is often characterized by higher taxes, closed loopholes, and vetoed pork-barrel spending. Think of Ronald Reagan's second term, when he agreed to a series of tax hikes in 1986. He would never have done so if his party had been faced with an imminent presidential election. That's why markets have historically been flat in the second year of a presidential term.
Of course, Washington has been so gridlocked that only a few bits of legislation were passed in 2010. Perhaps because of that gridlock, the S&P 500 managed to move up to 1140, good for a 9% gain.
The market usually rises about 15% in the third year of a presidential cycle, as the president typically looks to push through a series of economy-stimulating moves ahead of election season. In this instance, gridlock has not been helpful as it created Armageddon scenarios in the eyes of investors. As of now, we’re looking at a flat year for the S&P 500. Add the three years together, and the S&P 500 has actually dropped about 3%.
So to recap, we had two years of solid outperformance and one year of underperformance. Perhaps the fourth year of the cycle will prove to be more advantageous. Indeed, the final year of a cycle tends to deliver 4% gains, and the fact that the S&P 500 is already up around 11% from the end of September can be seen as an offset to the prior three year’s underperformance. Still, it may be prudent to trim expectations for the coming three quarters.
Nevertheless, certain sectors can be clear beneficiaries of the fourth year of the cycle. For example, media firms such as broadcasters, advertising agencies and even -- dare we say -- print publications tend to see a big uptick in spending as campaign funds get spent on the candidates.
Viacom (VIA.B) may be set up for a good trade. The operator of Comedy Central, Nickelodeon and MTV Networks may see a big spike in ad rates as candidates court the 20-something vote. The stock is already benefitting from a hefty $10 billion stock buyback that could shrink the share count by around 10% by the end of 2012.
Business at those cable channels has been solid in 2011, but it’s the Paramount movie studio division that gets some credit as well. The studio had been operating at breakeven in recent years but is on track to post 6% operating margins this year. That still trails rival Warner Brothers, which generates 12% operating margins of around 12%, implying room for further gains in 2012. Still, we’re talking about a Prez. Cycle boost. “The upcoming calendar year stands to benefit from what is likely to be an extremely contentious political season that should provide a solid baseline for growth,” note analysts at Barrington Research.
Ad agencies can be counted to craft clever marketing campaigns for firms that want exposure to the upcoming 2012 Olympics in London next summer. While many investors focus on industry titan Omnicom (OMC), which sports a $12 billion market value, rival Interpublic (IMG), with just a $4 billion market value, may be the better play. That’s because the advertising firm is wrapping up a multi-year restructuring plan that would look really impressive were it not for the still-slow economy.
A half-decade ago, Interpublic found itself with too many layers of management after a big growth-through-acquisition phase. Starting in 2006, management sought to trim the fat wherever possible, and EBITDA margins have been trending upward in recent years.
The real payoff: free cash flow, after trending negative in 2005 and 2006, has been surging, to a recent $701 million in 2010. That’s fueling a string of stock buybacks.
Heading into the “presidential cycle” year, Interpublic is already delivering solid results. Third-quarter revenue rose 10.6% to $1.73 billion, about $75 million ahead of consensus forecasts. That helped the company deliver EPS of 16 cents -- 60% ahead of forecasts.
Even in a still-restrained economy, where analysts see Interpublic’s revenue rising a modest 2% to 3% in 2012, profits are expected to march steadily higher. Citigroup sees EPS rising from around 60 cents this year, to around 70 cents in 2012 and around 80 cents by 2013. The fact that Citigroup and others foresee such tepid economic growth in 2012 -- right as campaign and Olympics-related spending should be at a cyclical high -- tells you that Interpublic may once again be poised to surpass expectations.
At the time of publication, author had no positions in stocks mentioned.