Profiting from a Presidential Election

CFA Institute

Profiting from a Presidential ElectionAuthor(s): Gerald R. Hobbs and William B. RileySource: Financial Analysts Journal, Vol. 40, No. 2 (Mar. - Apr., 1984), pp. 46-52Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4478732 .

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by Gerald R. Hobbs and William B. Riley

Profiting from a Presidential Election

Can trading strategies be developed to take advantage of observed patterns of stock price behavior surrounding presidential election dates? An analysis of average daily profit (loss) figures for the mid-September to Christmas period of every election year from 1900 to 1976 reveals that optimal trading strategies vary depending upon the outcome of the election.

For the 10 elections won by Republicans, the optimal strategy would have been to buy roughly 39 trading days before the election and to sell roughly 27 trading days after the election, for an average profit of 7.33 per cent. In the case of Democratic victories, the optimal strategy involved buying 49 calendar days before the election, selling short within two days after the election and closing out the short position approximately 42 days later, for an average gain of 5.0 per cent.

Market behavior, hence optimal trading strategies, also differ somewhat between landslide victories and close elections and between incumbent party wins and losses. Examination of the 13 elections won by incumbent parties suggests a strategy of buying 42 days before the election and selling 13 days after, for a gain of 8 per cent. The historical evidence from incumbent party losses suggests the possibility of selling short in anticipation of a market decline after the election.

IT IS SHORTLY AFTER Labor Day-the traditional start of the campaign season. Both presidential nominating conventions are

over, and each party has selected its candidate. You are examining the early political preference polls, making your own guesses about the outcome of the coming election and wondering whether you can turn them into potentially profitable stock market trading strategies.

Previous research has found evidence of stock market cycles during presidential election periods.' A plot of cumulative average residuals was found to be strongly positive following a Republican victory but negative following a Democratic victory. The question remains whether trading strategies can be developed to take advantage of these patterns.

Developing Trading Rules One possible approach to developing trading rules is to try every combination of buy and sell days during the period under examination,

picking the combination that, on average, yields the maximum profit. Using average daily profit (loss) figures over the 20 presidential elections of this century, one can determine, a posteriori, the optimum times to buy and sell during any fixed period.

The return (positive or negative) to be realized from buying on day a and selling on any following day b, both in year y, may be computed as follows:

G Xb - Xa

Ga,b,y - Xa (

where Xa and Xb are the closing values of the Dow Jones industrial average (DJIA) for days a and b.2 (Note that this computation does not consider any strategy that involves buying in one year and selling in another.)

Averaging values of Ga,b,y across all election

1. Footnotes appear at end of article.

Gerald Hobbs is Associate Professor of Statistics and Wil- liam Riley is Associate Professor of Finance at West Virginia University

FINANCIAL ANALYSTS JOURNAL / MARCH-APRIL 1984 O 46



years, one obtains Ga,b-the average return realized through the consistent pattern of buying on day a and selling on day b of presidential election years. Of course, myriad factors other than an election may affect the DJIA in any given year; over the 20 elections of this century, however, these extraneous (to this study) influ- ences may be expected to be "averaged out."

Figure A presents, for example, a hypothetical plot of the average daily return (GIb) that would have been realized by buying on day 1 and selling on each successive day b during the period from 50 days before to 50 days after the election day. The continuous curve through the data points represents an "election psychology" factor affecting the DJIA. The individual points may be thought of as the sum of this determinis- tic component and a random factor whose ex- pectation is assumed to be zero.

The return obtainable from our strategy may also be computed as follows:

Gab G- b - a (2)

Thus, for any fixed a (i.e., holding the buy date constant), Ga,b will be maximized when G,b is maximized. The best sell date occurs, for any buy date, at the high point of Figure A, subject only to the condition that the buy date must precede the sell date. Similarly, the best time to buy corresponds to the date when G,b is a minimum. The optimum historical strategy, then, involves buying at m where m is such that:

Gim = min {GIb} (3) all b

and selling at M where M is such that

G1,M = max {G l.b}. (4) all b

At first glance, it would appear that a good estimator of the profit potential of such a strategy would be:

Gm,M m - . (5)

This does indeed represent the profit one would have realized if one had followed that strategy over the last 20 elections. But it is almost certain- ly an optimistic estimate.

In Figure A, Gim and G1,M are represented as X and Y, respectively. Note that X is below the election trend and Y is above it. In fact, the highest individual value will almost always be above the trend line, and the lowest individual value below it.

Letting G'Ib denote the values that are on the election psychology trend line, we have:

G GIM G m (6)

G'mM 1 + Gm (6)

which represents the true expected return real- izable by buying on day m and selling on day M. Gm,M overestimates this return because, typ- ically, GI,M > G'CiM and Gi m < G'i,m. Neverthe- less, for the range of values of Gm,M considered in this article a good approximation of the realized return from buying on day m and selling on day M is:

G'mM =-Gl,M - G ,m. (7)

The vertical distances between the high and low points in Figure A are, then, good approxima- tions of the returns discussed.

Estimating True Profit Potential We use a method of direct assessment,

known as the jackknife, to arrive at an unbiased estimate of the true profit potential associated with a particular strategy.3 The method involves calculating Gib for each b on the basis of data from all but one of the elections, say the first. Buy date and sell dates determined on the basis of these 19 election periods are then applied to the single omitted election period and the average resulting gain or loss recorded. The process is repeated until each one of the 20 election periods has been left out once.

The 20 results corresponding to the 20 sepa-

Figure A Hypothetical Election Psychology Curve

Average Daily Return

y 0

x

E-50 E E+50

Days Surrounding Election

FINANCIAL ANALYSTS JOURNAL / MARCH-APRIL 1984 O 47



Table I Average Gain (Loss) For 20 Elections in This Century

'00 '04 '08 '12 '16 '20 '24 '28 '32 '36 '40 '44 '48 '52 '56 '60 '64 '68 '72 '76 All

Day WEEKEND - 50 -.44 -.45 -.54 -.52 -.52 -.45 -.48 -.55 -.35 -.46 -.58 -.54 -.48 -.46 -.50 -.38 -.51 -.54 -.50 -.48 - 0.49 -49 -.34 -.27 -.38 -.43 -.42 -.39 -.41 -.43 -.45 -.35 -.53 -.47 -.42 -.38 -.34 -.29 -.39 -.45 -.-39 -.36 - 0.39 -48 0.32 0.26 0.26 0.12 0.14 0.15 0.05 0.14 -3.3 0.25 - .01 0.07 0.14 0.15 0.27 0.21 0.16 0.13 0.18 0.19 0.13 - 47 0.23 0.08 0.14 -.12 -.12 -.09 -.13 -.04 -.49 0.02 -.20 -. 10 -.06 -.03 0.08 0.03 -.06 -.09 -.01 -.05 - 0.05 -46 0.67 0.47 0.53 0.32 0.26 0.27 0.30 0.40 - .14 0.42 0.23 0.34 0.41 0.40 0.50 0.54 0.40 0.35 0.41 0.36 0.37

WEEKEND - 43 0.42 0.03 0.29 -.10 -.12 -.04 -.06 -.00 -.30 -.00 -.29 -.09 0.10 0.01 0.14 0.23 -.02 -.07 0.07 -.02 0.01 -42 0.60 0.21 0.52 0.06 0.04 0.20 0.09 0.19 - .14 0.18 - .07 0.11 0.26 0.19 0.41 0.44 0.17 0.08 0.26 0.06 0.19 - 41 0.84 0.41 0.65 0.27 0.24 0.47 0.28 0.44 - .10 0.42 0.16 0.35 0.48 0.41 0.64 0.74 0.40 0.41 0.43 0.29 0.41 -40 0.68 0.42 0.57 0.24 0.16 0.51 0.30 0.48 0.07 0.40 0.18 0.34 0.47 0.39 0.63 0.69 0.38 0.32 0.37 0.30 0.39 - 39 0.66 0.31 0.47 0.18 0.06 0.47 0.24 0.40 0.00 0.42 0.18 0.27 0.39 0.33 0.61 0.54 0.30 0.25 0.32 0.24 0.33

WEEKEND - 36 0.52 0.16 0.45 0.10 0.05 0.54 0.24 0.28 - .03 0.29 0.09 0.19 0.43 0.28 0.63 0.51 0.24 0.19 0.26 0.16 0.28 - 35 0.58 0.21 0.49 0.10 0.04 0.52 0.25 0.34 - .01 0.31 0.04 0.21 0.40 0.32 0.57 0.56 0.26 0.17 0.27 0.28 0.30 - 34 0.25 -A11 0.12 -.25 -.30 0.25 -.13 0.03 0.07 0.01 -.33 -.16 0.03 0.00 0.19 0.20 -.07 -.01 -.04 -.03 - 0.01 - 33 0.34 0.10 0.30 - .06 - .17 0.44 0.05 0.13 0.21 0.15 - .16 - .02 0.21 0.15 0.34 0.30 0.11 - .04 0.17 0.13 0.13 - 32 0.19 -.04 0.12 -.16 -.21 0.26 -.01 0.01 0.37 -.04 -.22 -.15 0.05 0.04 0.21 0.16 -.01 -.18 0.04 0.07 0.02

WEEKEND - 29 -.00 -.34 -.10 -.39 -.29 -.03 -.23 -.19 0.48 -.32 -.43 -.34 -.22 -.17 -.01 -.06 -.25 -.42 -.20 -.14 - 0.18 - 28 0.31 - .04 0.20 - .07 - .02 0.28 0.11 0.09 0.56 - .05 - .01 - .02 0.12 0.16 0.33 0.25 0.08 - .09 0.11 0.25 0.13 - 27 0.64 0.17 0.43 0.15 0.28 0.54 0.37 0.21 0.36 0.17 0.25 0.19 0.34 0.37 0.53 0.54 0.33 0.36 0.39 0.55 0.36 - 26 0.09 -.44 -.04 -.37 -.12 0.05 -.17 -.33 0.51 -.35 -.25 -.12 -.19 -.13 0.01 -.03 -.18 -.34 -.07 0.01 - 0.12 - 25 0.41 - .14 0.37 0.07 0.24 0.50 0.30 0.26 0.54 0.06 0.13 0.10 0.23 0.28 0.39 0.33 0.20 0. 08 0.37 0.48 0.26

WEEKEND - 22 0.40 - .08 0.49 0.29 0.26 0.73 0.42 0.18 0.86 0.42 0.30 0.27 0.39 0.42 0.59 0.54 0.37 0.23 0.62 0.75 0.42 - 21 0.67 0.17 0.77 0.67 0.45 0.67 0.88 0.45 1.05 0.43 0.53 0.52 0.67 0.72 0.87 0.85 0.65 0.45 0.85 1.06 0.67 - 20 0.63 0.23 0.70 0.54 0.44 0.89 0.77 0.41 0.78 0.44 0.48 0.48 0.57 0.75 0.84 0.81 0.62 0.63 0.76 0.89 0.63 - 19 0.72 0.36 0.84 0.68 0.59 0.98 0.90 0.55 1.03 0.61 0.62 0.65 0.70 0.93 0.96 0.98 0.81 0.58 0.90 1.09 0.77 - 18 0.94 0.58 1.06 0.86 0.77 1.21 1.11 0.68 1.53 0.80 0.86 0.90 0.93 1.12 1.20 1.27 1.01 0.76 1.08 1.32 1.00

WEEKEND - 15 0.92 0.66 1.26 1.02 0.85 1.43 1.25 0.90 1.68 0.93 1.06 1.12 1.07 1.29 1.37 1.47 1.15 0.92 1.19 1.43 1.15 - 14 0.97 0.77 1.26 1.09 0.91 1.48 1.28 0.91 1.81 1.02 1.10 1.18 1.11 1.37 1.43 1.59 1.19 1.01 1.25 1.48 1.21 - 13 0.86 0.66 1.13 1.07 0.84 1.36 1.18 0.78 1.66 0.92 0.98 1.10 1.00 1.35 1.38 1.43 1.10 1.12 1.16 1.37 1.12 - 12 0.85 0.70 1.08 1.02 0.81 1.34 1.12 0.77 1.55 0.94 0.99 1.07 0.97 1.28 1.34 1.32 1.08 0.91 1.12 1.37 1.08 - 11 1.13 0.84 1.38 1.34 1.04 1.58 1.38 1.15 1.72 1.19 1.27 1.33 1.14 1.52 1.56 1.62 1.34 1.15 1.41 1.67 1.34

WEEKEND - 8 0.95 0.58 1.10 1.08 0.80 1.25 1.12 0.73 1.52 1.00 0.95 1.03 0.86 1.21 1.26 1.31 1.05 0.88 1.12 1.38 1.06 - 7 1.14 0.73 1.23 1.28 1.00 1.47 1.30 1.02 1.87 1.15 1.15 1.24 1.06 1.43 1.47 1.48 1.28 1.13 1.28 1.54 1.26 - 6 1.00 0.41 1.10 1.08 0.72 1.34 1.12 0.86 1.86 0.94 0.92 1.04 0.88 1.26 1.37 1.28 1.12 1.09 1.02 1.33 1.09 - 5 1.39 0.84 1.47 1.54 1.15 1.74 1.49 1.20 2.23 1.30 1.26 1.42 1.33 1.64 1.68 1.64 1.51 1.34 1.40 1.73 1.47 - 4 2.04 1.47 2.16 2.21 1.79 2.39 2.11 1.89 2.65 1.95 1.94 2.10 1.99 2.25 2.32 2.27 2.18 2.04 2.01 2.34 2.11

WEEKEND - 1 2.69 2.17 2.94 2.99 2.53 3.15 2.90 2.61 3.20 2.75 2.69 2.86 2.73 3.01 3.05 3.04 2.95 2.83 2.79 3.12 2.85

ELECTION DAY + 1 2.47 2.05 2.78 2.97 2.51 3.14 2.80 2.50 3.39 2.59 2.79 2.84 2.91 2.96 3.06 2.96 2.92 2.78 2.76 3.13 2.82

2 3.53 3.13 3.88 3.92 3.61 4.36 4.02 3.64 4.27 3.69 3.70 4.00 4.02 4.10 4.27 4.05 4.10 3.93 3.90 4.29 3.92 3 3.52 3.23 3.89 4.13 3.73 4.49 4.07 3.71 4.15 3.82 3.86 4.08 4.29 4.18 4.38 4.17 4.17 3.99 3.96 4.47 4.01

WEEKEND 6 3.01 2.82 3.62 3.95 3.58 4.45 3.78 3.28 4.15 3.49 3.79 3.90 4.09 3.96 4.17 3.99 3.96 3.79 3.71 4.34 3.79 7 3.37 3.00 3.79 4.17 3.68 4.67 3.86 3.46 4.32 3.66 3.75 4.11 4.37 3.95 4.32 4.12 4.14 3.88 3.84 4.49 3.95 8 2.57 2.26 3.07 3.46 2.89 3.88 3.07 2.74 3.73 3.23 3.03 3.35 3.63 3.39 3.61 3.39 3.37 3.11 3.11 3.78 3.23 9 3.50 3.14 4.02 4.42 3.83 4.91 4.04 3.71 4.74 3.92 4.00 4.34 4.17 4.37 4.62 4.40 4.35 4.12 4.07 4.72 4.17

10 3.16 2.99 3.73 4.17 3.54 4.76 3.78 3.33 4.47 3.71 3.82 4.08 4.34 4.10 4.35 4.13 4.10 3.86 3.82 4.46 3.93 WEEKEND

13 3.39 3.20 4.07 4.46 3.81 5.12 4.05 3.58 4.71 4.00 4.15 4.36 4.57 4.37 4.71 4.42 4.36 4.17 4.12 4.72 4.22 14 3.64 3.54 4.34 4.72 4.08 5.38 4.25 3.73 5.01 4.20 4.43 4.60 4.83 4.57 5.02 4.71 4.59 4.42 4.34 4.99 4.47 15 2.91 2.78 3.69 4.04 3.44 4.82 3.56 3.07 4.65 3.50 3.82 3.91 4.16 3.83 4.38 4.02 3.86 3.81 3.59 4.30 3.81 16 3.44 4.64 4.55 5.06 4.26 6.32 4.33 3.27 4.64 4.36 4.64 4.64 5.24 4.77 4.64 4.64 4.82 4.59 4.64 5.35 4.64 17 3.13 2.74 3.70 4.00 3.43 4.89 3.60 2.93 4.65 3.62 3.83 3.91 4.10 3.84 4.29 3.96 3.86 3.71 3.57 4.21 3.80

WEEKEND 20 3.54 3.04 4.17 4.40 3.91 5.08 4.03 3.30 5.05 4.12 4.26 4.33 4.56 4.24 4.75 4.40 4.30 4.12 4.04 4.61 4.21 21 3.61 3.09 4.12 4.47 4.02 5.13 4.06 3.32 5.14 4.09 4.31 4.37 4.61 4.29 4.80 4.48 4.36 4.13 4.08 4.69 4.26 22 3.05 2.52 3.55 3.91 3.48 4.56 3.46 2.65 4.73 3.50 3.80 3.75 4.09 3.66 4.24 3.93 3.79 3.55 3.49 4.08 3.69

THANKSGIVING DAY 24 3.31 2.74 3.79 4.13 3.73 4.89 3.67 2.97 5.02 3.70 4.05 4.03 4.36 3.90 4.44 4.20 4.06 3.76 3.72 4.32 3.94

WEEKEND 27 3.41 2.75 3.89 4.17 3.81 4.93 3.79 3.14 5.05 3.77 4.09 4.07 4.48 3.98 4.43 4.30 4.18 3.85 3.78 4.43 4.01 28 3.57 2.88 3.94 4.24 3.87 5.01 3.84 3.16 4.89 3.88 4.17 4.13 4.57 4.05 4.50 4.34 4.32 3.91 3.88 4.52 4.08 29 3.23 2.91 3.67 4.03 3.59 4.78 3.57 2.87 4.66 3.67 3.93 3.88 4.29 3.81 4.19 4.04 4.06 3.84 3.59 4.28 3.84 30 3.16 2.86 3.56 3.86 3.43 4.50 3.36 2.97 4.41 3.46 3.76 3.67 4.06 3.65 3.94 3.83 3.83 3.51 3.38 4.08 3.66 31 3.13 2.63 3.40 3.82 3.31 4.39 3.26 3.05 4.17 3.35 3.63 3.51 3.90 3.53 4.01 3.66 3.72 3.39 3.26 3.94 3.55

WEEKEND 34 2.83 2.70 3.21 3.64 3.16 4.17 3.01 2.96 3.93 3.13 3.34 3.22 3.62 3.25 3.57 3.41 3.45 3.14 3.00 3.63 3.32 35 2.73 2.62 3.15 3.62 3.36 4.14 2.94 2.82 4.00 3.10 3.32 3.21 3.58 3.20 3.57 3.39 3.45 3.12 2.99 3.62 3.30 36 2.39 2.29 2.80 3.43 2.93 3.96 2.67 2.54 3.59 2.75 2.99 2.91 3.30 2.89 3.31 3.07 3.19 3.00 2.68 3.31 3.00 37 2.33 2.14 2.66 3.26 3.01 3.83 2.54 2.41 3.47 2.58 2.82 2.76 3.15 2.74 3.11 2.93 3.03 2.66 2.57 3.10 2.86 38 2.63 2.31 3.07 3.67 3.39 4.25 2.90 2.65 3.89 2.98 3.18 3.07 3.49 3.09 3.46 3.32 3.39 3.00 2.93 3.45 3.20

WEEKEND 41 2.32 2.04 2.86 3.32 3.09 4.12 2.48 2.40 3.63 2.66 2.94 2.80 3.17 2.78 3.14 2.96 3.11 2.74 2.71 3.15 2.92 42 2.40 2.13 3.02 3.50 3.26 4.17 2.62 2.44 3.88 2.81 3.11 2.95 3.34 2.93 3.28 3.12 3.29 2.92 2.88 3.27 3.07 43 2.05 1.91 2.')73 3.25 ' 31 7 4.0 2.3I1)11 2.0 3.6 I 7 2.5r,7 2.92)1 2714 313 l 2.6 3.01 7 2.8Q7 3.04 ' 2.8 2.6 3.02 2.84)



rate "strategies" are averaged to give a direct estimate of the profitability of the general trading strategy. Note that the 20 "strategies" will not always yield the same result; the consisten- cy of the buy and sell dates offers an important clue to the stability of the results.

Results of the Strategy Table I reports the results of applying the jackknife procedure to the first 20 elections in this century. The period examined varies from election to election, but extends roughly from mid- September to the Christmas period.4 While the designation (E - 49) refers to 49 calendar days prior to the election, we will occasionally make reference to trading days, which can be easily determined in the tables.

The first column in Table I shows the average profit (loss) realized by buying on day (E - 53) and selling on each successive day thereafter for the 19 elections of this century, excluding the 1900 election. Specifically, the 3.64 entry in Row (E + 14) means that, for the 19 elections considered, the average increase in the DJIA has been 3.64 per cent from day (E - 53) to day (E + 14).

In order to identify the best times to buy and sell, it is important to isolate the minimum and maximum of the series underlying the data of the first column. If the time series in this column were plotted, it would become apparent that the series is somewhat erratic. A simple, equal- weighted, three-point moving average was used to smooth the series. Note that the smoothed end points are obtained by "copying on"-i.e., the - 0.44 from the original series is also the value used in the smoothed series. For the first column, this procedure results in a minimum at day (E - 50) (end point) and a maximum at day (E + 27). The minimum and maximum were thus determined for each of the first 20 columns of Table I.

These data provide evidence of the consisten- cy of the buy and sell dates. For example, 19 of the 20 buy dates occurred on the same Monday (E - 50), and the sell date was consistently day (E + 15) plus or minus three trading days. A conspicuous exception occurs in the first column, where day (E + 27) represents the high three-day average.5 The last column represents the average profit (loss) figure for all 20 election periods and can be considered an indicator of future optimal action points.6

A jackknife validation involves applying the strategy developed in the first column (in which

1900 was left out) and applying it to the 1900 election. In 1900, the DJIA was 56.67 on day (E - 50) and 66.43 on day (E + 27), for a net gain of 17.2 per cent.7 This procedure was repeated for each of the remaining election periods. An investor following this strategy would have realized an average gain of 3.57 per cent and earned a profit in 14 of the 20 election periods.8

Democratic vs. Republican Victories Earlier studies of presidential elections have

noted differences in market reaction depending upon whether a Democrat or a Republican won the election.9 Table II reports the results of applying the jackknife procedure to the subset of Republican victories.

To assess the true profit potential associated with Republican victories, optimal buying and selling dates were determined for each group of nine of the 10 elections won by Republicans. Applying these strategies to each omitted election period yielded an average profit of 7.33 per cent over the 10 election periods. The buy date was consistently (E - 39) plus or minus five trading days and the sell date (E + 27) plus or minus three trading days. The investor would have realized a gross profit in eight of the 10 periods.

Applying the jackknife process to Democratic victories yielded an average profit of 2.4 per cent over the 10 elections won by Democrats (see Table III). A gross profit was realized in seven of the 10 cases. The buy date was 49 calendar days prior to the election and consistent within plus or minus one day. The sell days were consistently from one to three days after the election.

Although the election of a Democratic presi- dent tends to have a negative impact on the DJIA during the period after the election, there is, on average, a slight rise just after election day. This may be attributable to the removal of

Table II Republican Victories

Year Buy Sell Profit

1900 E - 35 E + 27 +21.8 1904 E-35 E +28 +24.7 1908 E-35 e+27 +9.2 1920 E-42 E+27 -23.8 1924 E - 42 E + 27 +6.0 1928 E-42 E+27 +20.3 1952 E - 42 E + 27 +4.4 1956 E - 42 E + 24 -1.7 1968 E - 42 E + 27 +4.8 1972 E - 35 E + 27 +7.6

FINANCIAL ANALYSTS JOURNAL / MARCH-APRIL 1984 3 49



Table III Democratic Victories

Sell and Cover Year Buy Go Short Profit Short Profit

1912 E- 50 E 20.7 E 44 ?5.7 1916 E -50 E +3 ? 9.3 E + 24 + 1.4 1932 E -49 E +2 - 2.9 E +45 ? 15.4 1936 E -50 E + 292 E +44 ? 0.8 1940 E -50 E +3 ? 5.6 E?+44 + 6.1 1944 F - 50 E ? 3 ? 2.3 E ? 44 - 1.5 1948 E -50 E +3 - 0.6 E?+44 ? 1.5 1960 F- 50 EF?3 ? 3.7 EF?44 - 0.8 1964 E-50 E?+3 ? 1.2 EF?44 + 1.5 1976 ES F? +3 - 4.1 E +44 - 3.9

Table IV Landslide Elections

Democratic Landslides Year Buy Sell Profit

1912 E - 6 E + 6 -0.1 1932 E - 50 E + 4 +0.8 1936 E - 6 E + 4 +3.9 1940 E - 6 E + 4 +2.8 1964 E - 6 E + 4 +0.1

Republican Landslides Year Buy Sell Profit

1904 E - 35 E + 29 +17.1 1920 E - 48 E + 49 -15.9 1924 E- 33 E+27 +4.5 1928 E - 33 E + 27 +11.8 1952 E - 33 E + 27 +1.9 1956 E - 50 E + 24 -5.7 1972 E - 34 E + 27 +5.5

Table V Close Elections

Year Buy Sell Profit

1900 E - 48 E + 31 +15.4 1908 E - 42 E + 16 +12.5 1916 E - 42 E + 41 -3.3 1944 E-42 E+ 15 +0.3 1948 E - 42 E + 16 -1.4 1960 E - 42 E + 15 +4.8 1968 E - 42 E + 15 +2.9 1976 E - 42 E + 15 -7.6

uncertainty about the outcome of the election. In any event, this behavior suggests that a profitable strategy might involve selling short during this brief period, approximately (E + 2), and closing the position sometime later, approximately (E + 44). Table III shows that this strategy yielded an average gain (decrease in the DJIA) of 2.6 per cent (profitable 70 per cent of the time).

Table III also reports the results of combining the two strategies for Democratic victories-that is, buying before the election, selling and going

short just after the election, and closing out this position after the market has had time to react negatively. With this combination, gains were realized in nine of 10 election periods, with an average gain of 5.0 per cent.

Landslides Most elections since 1900 have not been close.

In fact, 12 of the 20-five Democratic and seven Republican-can be classified as landslide victories in which the winning candidate received more than 55 per cent of the total vote.' 0 One may assume that the outcome of a landslide election is reasonably certain for some period prior to election day. Can this information be used to form a profitable strategy?

We examined all landslide election periods, without party identifications, using the jackknife procedure. A negligible profit (0.9 per cent) was observed. Identifying the landslides by party, however, resulted in a different outcome-reported in Table IV. As might be expected, the pattern of buying and selling differs between Democratic landslides and Republican landslides.

An examination of the five Democratic landslides suggests a strategy of buying roughly 49 days prior to the election and selling roughly three days after the election. The average gain was 1.5 per cent, with the strategy yielding a profit in four of five elections. In the case of Republican landslides, one should buy approximately 33 days prior to the election and sell roughly 27 days after the election. This strategy resulted in an average profit of 2.7 per cent and losses in only two of seven elections.

Market behavior differs somewhat between landslide elections and close elections. Table V reports the optimal buy and sell dates for the eight close elections since 1900. The average

FINANCIAL ANALYSTS JOURNAL / MARCH-APRIL 1984 C 50



gain from buying on day (E - 41) and selling on day (E + 15) was 2.95 per cent.

A further division of the close elections by outcome-Republican or Democratic victory- was not attempted, because by definition the outcome of a close election is not easily antici- pated. However, at some point prior to an election, a particular party may have sufficient advantage to enable one to conclude that, although that party may lose the election, it will not be by a landslide. An examination, via the jackknife procedure, of all elections that did not result in a Democratic landslide yielded an average gain of 5.3 per cent for a strategy of buying 37 days before and selling approximately 21 days after the election. This procedure, when applied to all elections that did not result in a Republican landslide, suggested buying about 43 days prior to the election and selling roughly three days after, for an average gain of 3.0 per cent. The results are detailed in Table VI.

Wins and Losses by Incumbent Parties Previous studies have noted the market's

aversion to the uncertainty that a change in party entails and, conversely, the market's preference for an incumbent party's retaining office. ' The incumbent party has lost seven elections in this century and retained office in 13. Examina- tion of these 13 elections (Table VII) reveals that a strategy of buying on day (E - 42) and selling -on day (E + 13) would have resulted in a gain of 8 per cent. This, however, obscures the fact that Republican victories were associated with a 12.1 per cent gain, while Democratic victories yielded only 3.2 per cent.

Incumbent party losses suggest the possibility of selling short in anticipation of a market decline after the election. The buy date associated with this strategy is roughly (E - 47) and the sell date (E + 49), for a 3.8 per cent profit. The high variability of the buy and sell dates, however, reduces the chances of profiting from an expected incumbent party loss.

Table VIII presents a summary of statistical tests of the significance of the returns from all the possible strategies.

Possible Scenarios'2 It is early September, and the Republican candidate has a commanding lead. You may reasonably expect one of the following outcomes-(1) a Republican victory, (2) a Republican landslide, (3) a close election or (4) all but a Democratic landslide. These outcomes suggest a strategy of buying between (E - 41) and (E - 27)-a two- week period roughly spanning the last week in September and the first week in October.

If, on the other hand, the Democratic candidate has a substantial lead, you might expect (1) a Democratic victory, (2) a Democratic landslide, (3) a close election or (4) all but a Republi- can landslide. The buy dates associated with strategies reflecting these outcomes are between

Table VI All Elections But Landslides

All But Democratic Landslides

Year Buiy Sell Profit

1900 E - 48 E + 14 +24.0 1904 E - 42 E + 15 +22.3 1908 E - 48 E + 21 +9.2 1916 E - 42 E + 22 + 4.5 1920 E - 42 E + 28 - 13.0 1924 E - 42 E + 22 +5.8 1928 E - 42 E + 24 +22.0 1944 E - 42 E + 22 +0.9 1948 E - 42 E + 27 -3.7 1952 E - 42 E + 22 +4.0 1956 E - 42 E + 23 - 3.0 1960 E - 48 E + 22 +0.5 1968 E - 42 E + 22 +4.0 1972 E - 42 E + 22 +8.8 1976 E - 42 E + 27 -6.4

All But Republican Landslides

Year Buiy Sell Profit

1900 E - 50 E + 3 +15.0 1908 E - 50 E + 15 + 5.3 1912 E - 50 E + 15 -0.6 1916 E - 50 E + 3 +10.3 1932 E 50 E + 15 -8.6 1936 E -50 E + 15 +10.5 1940 E -50 E + 15 +2.1 1944 E -50 E + 15 + 1.5 1948 E -50 E + 15 -1.8 1960 E -50 E + 15 +2.7 1964 E -50 E + 15 + 2.9 1968 E -50 E + 15 + 4.8 1976 E -50 E + 15 - 4.6

Table VII Incumbent Victories

Year Btuy Sell Profit

1900 E - 48 E + 15 + 24.0 1904 E - 46 E + 15 +24.1 1908 E - 48 E + 15 + 8.3 1916 E - 46 E + 15 + 7.8 1924 E - 47 E + 15 +6.6 1928 E - 48 E + 15 +17.1 1936 E - 47 E + 16 +9.6 1940 E - 46 E + 15 +0.5 1944 E - 46 E + 15 -2.5 1948 E - 48 E + 15 +0.9 1956 E - 48 E + 15 -4.3 1964 E - 46 E + 15 +3.1 1972 E - 48 E + 15 +8.5




Table VIII Statistical Summary

Average Standard Type of Election Return Error T-Valuea Significanceb

All 3.57 2.25 1.59 c Democratic Victoryd 5.06 1.93 2.62 0.05 Republican Victory 7.33 4.23 1.75 0.10 Incumbent Victory 7.98 2.43 3.29 0.01 Dem. Landslide 1.50 0.71 2.12 near 0.10 Rep. Landslide 2.74 3.83 0.72 c Close 2.95 2.58 1.14 c All But Dem. Landslides 5.33 2.68 1.99 0.10 All But Rep. Landslides 3.04 1.71 1.78 0.10

a For a test of the hypothesis that the corresponding population mean is zero. b Two-tailed significance probability of the observed outcome. c Not significant. d Result for combination strategy.

(E - 49) and (E - 41)-approximately the third week in September.

If the mid-September political preference polls indicate that the election is too close to call, you may assume the race will stay tight for the remaining seven weeks until the election. The buy date associated with close elections is approximately (E - 41), which corresponds to September 24, plus or minus four days.

All that remains is to wait for Election Day. If a Republican wins, you should hold until about (E + 27)-December 3, plus or minus four days. The sell date, historically, is not affected by the margin of victory, nor by the assumptions underlying the purchase. Given a Democratic victory, you should close the long position and sell short roughly three days after the election, closing out the short position on about (E + 44)-December 20, plus or minus four days. E

Footnotes

1. See W. Riley and W. Luksetich, "The Market Prefers Republicans: Myth or Reality," Journal of Financial and Quantitative Analysis, September 1980, pp. 541-560

2. While we recognize that the S&P 500 is a much broader and more representative index of the market, daily prices for the DJIA are available in a more consistent manner since 1900. Also, Lorie and Hamilton found a very close relation between the DJIA and the S&P 500 (R2 = 0.976) for the period 1926 to 1966 (see James H. Lorie and Mary T. Hamilton, The Stock Market (Homewood, Ill.: Richard D. Irwin, 1973), pp. 65-68). In addi- tion, the DJIA is more widely followed by the general public than the S&P 500.

3. For a complete discussion of this procedure, see F. Mosteller and J. W. Tukey, Data Analysis and Regression (Reading, Mass.: Addison-Wesley, 1977), pp. 133-164. One advantage of the jackknife as a validation tool lies in the fact that only

one observation at a time need be held out of the strategy-making process. Traditional validation techniques, which hold out half the sample points, would in this situation leave little data on which to base strategy decisions.

4. We recognize that any period selected is somewhat arbitrary. The period chosen starts at the conventional beginning of the campaign season and extends for an equal period following the election. Earlier examination of larger periods exhibited nothing of particular importance be- yond the period examined here.

5. It is constructive to note that (E + 27) and (E + 15) are extremely close in terms of three-day moving averages.

6. While the last column closely approximates the simple average of the figures in the prior columns, it differs slightly because of a combination of rounding error and market interruptions.

7. All returns reported in the study are gross returns. Transaction costs will reduce the profit by varying amounts.

8. As a frame of reference, the DJIA rose from 68.13 on January 2, 1900 to 1,004.65 on December 31, 1976. This represents an average daily gain of 0.0016 per cent. An "average" 55-trading-day period involves the DJIA gaining two-thirds of 1 per cent.

9. Riley and Luksetich, "The Market Prefers Repub- licans," op cit.

10. The elections of 1912 and 1924 were exceptions to this definition because of a significant third-party challenge. In both cases, the winning candidate received less than 55 per cent of the total vote yet defeated his nearest rival by more than 10 per- centage points.

11. Riley and Luksetich, "The Market Prefers Repub- licans," op cit.

12. The results described above are not conditioned on knowledge of the polls or any other information likely to be useful for the scenarios described below. Thus the prior results may not be good guides to the potential profitability of the strategies discussed below.




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Profiting from a Presidential Election