The rising power of the Federal Reserve has rendered the presidential cycle of market investing largely dead, according to Jeremy Grantham, the chief investment strategist of asset manager GMO.
“They are constantly looking for excuses to push down on interest rates and drive asset prices higher to get some wealth effect. I don’t trust them any more to play the easy presidential cycle,” Grantham said in a recent interview with the Financial Times.
The GMO founder, based in Boston, has shown through research dating back to 1932 that the third year of a president’s term could top those of the other three years of their leadership.
On average, U.S. stocks improve about 0.2% each month in the first, second and fourth years of a presidential cycle. However, in the third, stocks return an average 0.75% to 2.5%.
“The presidential cycle owed everything to the Fed. The Federal Reserve, completely innocently, always decided to come to the aid of the party in power,” said Grantham.
The general theory he has described entailed revving up the economy in the third year of a president’s term, so that the economic benefits would be felt as votes were cast in the fourth year. Stock markets, which generally signal anticipated economic developments, tend to move up ahead of this growth in year three, according to Grantham.
The Federal Reserve board members did not take action to stimulate the economy earlier in the cycle “or everyone would have forgotten about them by year four,” he states.
“The Fed can move stock prices. In the old days it was about all they did. They helped along year three, and their efforts in year three would feed through into the economy in year four — which it did,” Grantham told the FT.
In fact, the portfolio guru referred to this cycle when alerting investors to the possibility of a stock bubble in 2015, when President Obama was in the third year of his second term.
Changing of the Guard
However, the significance of the cycle is no more. Since the time of Fed Chair Alan Greenspan — the Federal Reserve has become “the dominant force in economics and finance and assumed enormous power,” he says, putting its influence ahead of politicians.
For instance, in the third year of Obama’s first term, 2011, the stock market was flat. In 2015, it declined about 0.73%.
With Greenspan’s “more aggressive policy,” the Fed’s approach changed. “They didn’t get the principle that you are meant to pull back in years one and two and wait until year three,” explained Grantham. “Greenspan stimulated in years one and two as well.”
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