It seems too good to be true, and it is. This, in short, sums up the industry experts’ response to the recent media reports linking the U.S. election cycle to rallies in stock markets promising pay dirt.

Calling it the “best formula going” these reports claim “shares usually fall or drift during the first half of a president’s term,” and then ” like clockwork” in the second half the stock market booms and offers “outsized gains.”

Myles Zyblock, chief institutional strategist and director of Capital Markets Research at RBC Dominion Securities Inc., dismisses the “formula” summarily calling it “interesting” and “entertaining at cocktail parties.”

“It’s not a theory at all,” he says. “I don’t think anyone relies on this formula. It gets a lot of press, but I don’t think anyone’s practising it.”

Equally dismissive is James Marple, senior economist, TD Bank Financial, who says there is no consistent evidence to support this claim. “If this was such a predictable measure that stock markets rise around (a part of) a presidential term, (it would be) arbitraged away by those looking at the other side who’d buy in the first two years of a presidential term and sell in the second two.”

If anything, he says, things work the other way round. “What you do tend to see is the causation going the other way,” says Marple indicating that economic performance is a strong predictor of the results of an election.

He cautions anyone who may be tempted to ride the U.S. election tide that “past performances often are a poor predictor of future performances.” It would be “a really poor investments strategy” if market players played based on past elections “without watching what’s happening in the economy.”

There are no academic journals or data that would point to such a pattern. “This points to consistent irrationality and behaviour for this type of pattern to arise.” Marple also rejects claims made by the reports that most presidents hack budgets and increase tax in the first two years of their administration and spend in the second half. “I don’t think it’s going to play out like this if you look at the reality of budget deficit.”

Zyblock concedes an association between the U.S. election cycles and rising stocks is empirically relevant but insists investment decisions should be rooted in underlying fundamentals instead. “People have looked at election cycles and have associated decent returns with those election cycles.”

The correlation supports the thesis that following mid-term elections is a pretty good period for stocks, says Zyblock, but warns causation and correlation are two different things. “I wouldn’t stake my portfolio or my retirement nest egg on this particular study.”

The only reason why the relevance of the U.S. presidential cycles’ ‘buy signals’ may extend to the Canadian market is because the U.S. and Canadian markets are closely correlated.

“What matters for the Canadian markets is the overall performance of the U.S. economy,” says Marple. “The increased certainty an election gives, that you know now who is going to be in Congress at least for the next two years, will allow some policies to actually get made and that could be positive (for the stock market).”

(11/01/10)

Originally published on Advisor.ca