Election Cycle Portfolio

Election Cycle Model Performance

The Presidential Election Cycle,   (Article by Arthur J. Minton, Ph.D.)

The Alpha Election Cycle Portfolio is designed for investors seeking a long-term, systematic approach to risk management. The primary objective of this program is to avoid large losses, which can cost investors years of compounding, not to mention the stress of coping with the uncertainties of recovery. This is particularly important for investors in retirement and just before retirement, when investments may become sources of income in the near future.

The stock market is intrinsically cyclical. Periods of high returns are followed by periods of low returns, transitioning again to periods of high returns. Historically, this cyclicality has tended to follow a four-year pattern.

The four-year market cycle is closely correlated with the presidential election cycle. The best years of the market cycle are the pre-election and election years of the election cycle. The inaugural year and mid-term year of the election cycle tend to correspond to the weakest part of the market cycle.

Election cycle theory asserts that politics has a profound affect on the stock market. The robust returns in the market in years three and four of the presidential term can be explained by the natural desire of incumbent politicians to retain power. Politicians understand that voters are concerned primarily with job security and economic prosperity. Troubled economies tend to produce turnover in Washington, while prosperity is a virtual guarantee of re-election. Therefore, the political establishment prepares the way for prosperity and good feeling by undertaking pro-business, pro-investment initiatives in the pre-election year. These initiatives include reducing taxes, pro-business regulations, a de-emphasis on new government spending programs and generally conservative fiscal policy. The political class is assisted by the actions of the Federal Reserve, which tends to adopt a more accommodating monetary policy during the pre-election and election years.

In contrast, the first year of the presidential term tends to be the time when new government programs are created, taxes are raised, wars initiated, and anti-business regulations are passed. The Federal Reserve also leans toward restrictive monetary policy, often raising interest rates and decreasing the money supply in an effort to suppress the inflationary effects of their previous expansionary behavior. Naturally, these actions are felt in the financial markets.

Of course, the stock market is also influenced by many factors outside the political arena, but the effects of these longer-term economic trends are enhanced or diminished by the persistent self-serving behavior of the political class.

Alpha's Election Cycle Portfolio program is designed to exploit the opportunity provided by the regularities of the election cycle. Our primary objective is to minimize the cyclical risk to investor portfolios by adopting a conservative, low-exposure stance to the market during the periods of the election cycle which have been consistently associated with market weakness.

Conversely, we will become aggressive, adopting a full market exposure, during periods which have proven to be the least risky and most productive parts of the election cycle.

Over the long-term, which we measure as two or more market cycles, our objective is to deliver returns comparable or superior to the market with less than half the downside volatility.

Alpha makes no claim that the election cycle strategy is perfect - no strategy is. However, the main components of the strategy have proven effective since World War II.

The first component is the avoidance of risk. Historically, the stock market is at greatest risk during year two of the presidential term. Bear markets, which often begin in year one, tend to climax in year two. This creates weakness in the first three quarters of year two and exceptional strength in the fourth quarter. This strength continues throughout year three (pre-election) and year four (election). Therefore, our portfolios have reduced market exposure in the first three quarters of year one (post-election) and year two (mid-term).

The second component is to exploit the superior returns of the pre-election and election years. Our exposure to the market is increased to 100% during the fourth quarter of year two and throughout year three. The pre-election year has delivered positive returns 100% of the time since 1939, averaging a 22% real return - about three times the market's long-term average. In the election year, we moderate our exposure early in the year, then become fully invested in the second half, when the market tends to advance prior to the election and throughout the final quarter. This 27 month period has produced gains 100% of the time since 1952, averaging 39.7% per period using the S&P 500 Index as the investment vehicle.*

Our strategy is implemented using no-load mutual funds and index funds. Fund selection is a vital part of our program. Portfolios are diversified and designed to exploit opportunities in mid-cap stocks as well as blue chips. During periods of partial equity exposure, intermediate bonds are used for the balance of the account.

The historical pattern for the election year calls for weakness in the first two quarters, then strength building in the late summer. There is a slight consolidation just before the election, then strength to year-end.

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