The Election Effect?

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If Wall Street has a Holy Grail, it's that long-sought predictor of future success. This election year is no different. In recent weeks, I've heard several investment strategists declare that stocks are sure to rise in the latter half of a Bush second term. But there's no reason to believe they will be right. Welcome to a forecasting folly called "the presidential cycle." In theory, it makes sense. As CEO of the U.S., the President can tighten the nation's belt in the first year or two of his term, then bust the budget in years three and four. That pattern would crimp corporate earnings and stock prices in the first half of a presidential term (giving savvy investors a chance to buy low), and boost them in the second half (time to take profits!).

History does show some correlation. Since the Coolidge Administration (1923-29), according to The Stock Trader's Almanac, stocks have gained an average of 14.5% in year three of a presidency and 7.7% in year four vs. less than 6% in year one and year two. But within those averages lurk vast annual variations. Under F.D.R., year one produced a 66.7% gain. The market's lousiest annual return ever — a 52.7% loss — occurred in the third year of Herbert Hoover's Administration. So you can lose your shirt betting the cycle will repeat itself on cue.

Wall Street's other piece of soothsaying wisdom — that a G.O.P. President will unleash the bulls because Republicans are good for business — isn't even supported by history. Finance professors Pedro Santa-Clara and Rossen Valkanov of the Anderson School of Business at UCLA have studied the linkage between Presidents and stock prices. They found that from 1927 through late 2003, stocks outperformed short-term Treasuries by an annual average of 12% under Democratic Presidents but by only 1.9% under Republicans.

Then again, I doubt that history is a reliable guide when it comes to Presidents. Jeremy Grantham, a money manager at the Boston firm of Grantham, Mayo, Van Otterloo & Co., notes that in the third years of U.S. presidential terms, markets in Britain and Japan, far from the influence of the Oval Office, have been even more bullish than those in the U.S. Why? Because there may be a pattern here but not a rule. Like the length of women's hemlines and the outcome of the Super Bowl, the apparently predictable effect of the presidency on stock returns is probably random.

Sometimes the best investing advice is to do nothing. Says Theodore Aronson, a fund manager at Aronson+Johnson+Ortiz in Philadelphia: "We elect to ignore the election cycle." Instead of trying to predict what the next President will do to the market, just make sure you have a diversified portfolio of stocks and bonds.

You can e-mail Jason, a MONEY columnist, at investor@moneymail.com