Why You Should Keep an Eye on This Year's Elections

Madhuchhanda is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With Election Day just over two months away, the presidential race is now running full-throttle. Perhaps you’re wondering if and how the 2012 presidential election could affect the stock market. Even though the U.S. president can't legislate bull markets or veto bears, that hasn't stopped historians from crunching stock returns to determine what impact politics has on stocks.

There is a plethora of presidential election investment theories. Some are quite well supported by facts, others are myths, and many fall somewhere in between. Despite the varied number of theories circulating the country, most analysts agree upon one particular trend – the Election Cycle.

What we can expect
Because of the consistency and predictability of administrative actions and campaign rhetoric, and their anticipated influences on the economy, investors have come to assume better times for stock prices in the period prior to a presidential election and a less robust period following those periods. Thus, a four-year stock market cycle seems to have become a part of the investment landscape since the mid-twentieth century. 

To illustrate this pattern, consider the historical performance of the commonly used Standard & Poor’s 500 Index (S&P 500). This Index consists of 500 top U.S. companies, and it is used by Wall Street as a benchmark for tracking the overall stock market. When one analyzes the history of these companies, a definite pattern emerges. And if history is a guide, the worst of the year may be behind for stocks; or at least that’s what Sam Stovall, noted stock market historian and S&P Capital IQ's Chief Investment Strategist, believes. 

According to his analysis, the S&P 500's performance mid-way through this election year hasn't been too far off base when compared with the average election year going back to 1900. The S&P’s monthly results saw gains in January, February, and March, followed by declines in April and May, and concluded with a gain in June.

According to the S&P’s historical election year performance, 78% of all election year lows usually occur in the first six months, and 85% of all highs happen in the second half, with 70% in the fourth quarter. That being said, the S&P 500 should rise 5%.

Are the companies really following this pattern?
We have to remember that market predictions, especially those based on presidential elections, is little more than a guessing game. Stovall’s analysis is only one among many; but so far, based on my research, I have found little fault with his reasoning. Let us briefly analyze some major S&P companies and their recent revenue reports.

One of the themes of this earnings season has been the disappointing revenue announcements.  Of the 447 S&P 500 companies that have announced their quarterly financial results, only 43% have beaten analyst expectations.  This is the lowest beat rate since Q1 2009. But if we are to follow Stovall’s analysis, the next quarter should be a lot more promising for these companies. Let’s take a look at the reports provided by Adobe (NASDAQ: ADBE), IBM (NYSE: IBM), and Vodaphone (NASDAQ: VOD).

Adobe trailed Wall Street's revenue estimates in its third quarter as the company ramped up its subscription business. The California-based firm reported revenue of $1.081 billion, below analyst expectations of $1.10 billion. One reason for the miss was that Adobe took a $9 million hit from currency losses. Needless to say, these results disappointed both the company and investors.

But Adobe has no intention of backing down. The software giant is expected to come back swinging, with analysts expecting the company to report revenue of $1.206 billion and EPS of $0.67 for the fourth quarter of 2012. The company's own predictions are far more modest, with revenue expectations of $1.075 billion to $1.125 billion, on a diluted earnings per share (EPS) basis. Although Adobe's transition to cloud platforms is somewhat sudden, sales figures seem to indicate that it's much desired. Contrary to original expectations, Adobe's prices, too, are on the rise. The fourth quarter may not beat any records, but it will certainly be a step towards coming highs.

Meanwhile, IBM’s third quarter results failed to impress investors used to a stellar showing from Big Blue, dragging its stock down more than 3%. The stock price fell to $179.70 in extended trade after closing down 2.1% on the day earnings were announced.

So does it follow the next-quarter-rising-analysis? Yes it does! IBM's forecasts for 2012 earnings are even better than analysts’ predictions. With recent restructuring in the company, sales are already at a new high. Fourth-quarter net income rose to $5.49 billion, or $4.62 a share, from $5.26 billion, or $4.18 a share, a year earlier. The comapny estimates that earnings will rise to $14.85 a share over analysts' predictions of $14.81.

Vodafone reported disappointing second-quarter numbers, with its share price declining a moderate 1.7%. With a 10% decline in revenues of Vodafone Spain, investors were already nervous about the new trend of mobile subscriber contraction. But few thought Vodafone would lose 3.7% of its entire subscriber base in a single quarter.

However, numbers are bound to improve in the third-quarter. Company officials have assured investors of increased efficience and implementation of better strategies. Also, with Vodafone receiving the green light for 4G in UK, things are looking up. As of Sep 25, 2012, the consensus forecast amongst 37 polled investment analysts covering Vodafone Group advises that the company will outperform the market. 

Similar reports were observed in other large S&P companies, like Apple, Google, Microsoft, Exxon Mobil etc. Thus, from the available data, we can say that these companies are following the pattern. The next quarter is to be of much higher value in terms on investment, and it seems we can all breathe a sigh of relief. Or can we?

Stock market predictions are rarely that easy. Although the companies may be following the election cycle now, how  global events and macroeconomics effect future dealings remain to be seen. The biggest threat now is bad news from China, according to Alec Young, S&P Capital IQ strategist. He also said investors should be cautious of more bad news from overseas by going long on the consumer discretionary sector while shorting materials. 

In conclusion, the only thing we can definitely say is that nothing is set in stone. It is possible that this election year will follow the norm, and it is possible it will not. My personal opinion is that investors should follow the cycle for now. If we can definitely understand the pattern, then this year's investments will be quite valuable. However, I would advise them to remain alert for breaks in the trend and for global factors that may change the current scenario.

Madhu60 has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines. Motley Fool newsletter services recommend Adobe Systems, Vodafone Group Plc (ADR), and Vodafone Group Plc (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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