Is Obama Good for the Stock Market?

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WASHINGTON (TheStreet) — Stock market returns are influenced by many factors. Interest rates, economic growth, currency exchange rates and expectations about the future play a part in returns, making projections difficult and risky.

One way to predict market performance is to look at presidential administrations. This may seem a little spurious at first, but the logic actually follows quite nicely.

Jeremy Grantham, chairman of the Boston-based asset manager GMO, echoed research by Marshall D. Nickles of Pepperdine University while speaking at the CFA Institute Annual Conference last week. Nickles' research, published in 2004, says the first and second year of a presidential term is usually marked by declining stocks. In the third year, stocks often generate above-average returns before retreating to averages in the fourth year.

This makes sense when you consider the way in which power is transitioned in the U.S. When the new administration takes over, the transition period is a lot of logistics and housecleaning while policy slowly takes shape. The first few quarters of a term can be a mishmash of old policy and new as the table is set for the next four years.

At this point, investors and companies are feeling out the new president to get an idea of how the next four years will play out and how their business may be impacted by Washington. This tentativeness can make buying slow and make bulls hesitant, keeping a lid on gains.

The second year sees more of the same as the first midterm election gets underway and the administration starts to get down to the business of putting in place objectives that may not have been marquee campaign promises, but are still viewed as critical to its vision.

By the third year, the vision for America that brought a president to the White House has likely taken hold and the country is probably feeling the effects of the regime's policy, without influence from the previous administration's actions on interest rates and spending. At this point, fiscal and monetary policies made under the previous leader no longer impact the new administration, which can take responsibility for the success or failure of the market and economy.

Nickles suggests in his 2004 paper that the most attractive strategy to exploit these trends would be to push into the stock market on Oct. 1 of the second year of the administration and sell out on Dec. 31 of the fourth year. This strategy would have turned $1,000 into $73,000 between 1952 and 2000. Those gains would have been severely hurt in the last year of President George W. Bush's tenure, when the market collapsed in the subprime crisis.

But how does this compare to now? During President Barack Obama's first year, stocks boasted returns of 26.5%, more than the projected negative returns of this theory. And in his second year, the market is heading for a weak year if current trends continue. Looking historically, these returns are much like those seen during the tenure of George H. W. Bush.

Stocks during the George H. W. Bush's one term saw a 29.9% gain in his first year, followed by a 3.5% loss in his second year. The third year saw a return to the averages, with a gain of about 27.7%.

That could prove to be a good model for the returns that Obama may see in 2011 as the world economy pulls out of a second slump brought on by a debt crisis in European countries, such as Greece and Spain.

Dow stocks like General Electric and Procter & Gamble should follow these trends closely because they tend to move in step with the broader market. When the market shows weakness in the first two years of a presidential term, GE and P&G are likely to decline. They should also see the jump in the third year as the market perks back up.

Another CFA Institute speaker Ian Bremmer, president of the Eurasia Group, predicted that 2011 will be the year of deficit reduction as America aims to cut down it massive budget to return to a surplus so that it can pay down the national debt. This may require austerity, which could be an impediment to growth and a drag on the market. But given the unease around the world about debt, deficit reduction may bolster the market. If the budget can be trimmed in a smart way, the process could result in more efficient governmental spending, which could give the Obama administration more bang for its budgetary buck.

These trends are by no means a rule, but thinking about cause and effect in investing in new ways can help investors set expectations. Consider the presidential effect when making investments.

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