The Dow Versus Election Season

The Dow Jones Industrial Average (^DJI 0.56%) has taken election season about as well as a toddler taking cough syrup. The index has plummeted more than 3% so far in October, spearheaded by two horrific days that have quickly erased virtually all the gains of the last three months. Earnings season certainly hasn't helped the markets, but many investors have cited uncertainty around the election -- and what politics will have in store afterwards -- in the Dow's recent woes.

It's hard for markets to plan ahead when major changes are afoot in the government -- particularly this year, when everything from the fiscal cliff to the evolution of health care is poised to affect the U.S. economy during the next presidential term. However, to get a better idea of just how much the Dow has reacted to the political headwinds in 2012, let's compare the market's performance leading up to the election with prior years.

What does the Dow tell us?
To keep data relatively recent, here's the performance of the Dow in the four-week period leading up to every presidential election since the end of the Vietnam War.

Sources: Google Finance and author's calculations.

Not a whole lot of correlation there. Context is needed, of course -- 2008 and 1980 each represented elections dominated by the talk of bad economies, particularly where the nearly 10% drop in 2008 is concerned. That year also forced investors through a meat grinder of volatility -- the Dow recorded two of its largest percentage gains and losses  of all time each in the four weeks leading up to the 2008 election. While the 2012 cycle still has another week to go, this year has proved to be one of the most sensitive markets in recent history.

Interestingly, the Dow's volatility leading up to the elections proved to be a rather horrible indicator of who would actually win the election. Out of years when the Dow fell, the incumbent party lost three times (1976, 1980, 2008) and won twice (1988, 2004.) Out of years when it rose, the incumbent party gained and lost power two times each. Once again, there's little correlation between the Dow's temperamental spikes and how politics would play out.

With that rather random scattering of data out of the way, let's see what the Dow's done in the weeks after the election.

Sources: Google Finance and author's calculations.

Once again, direct correlation between the Dow's activity after the election and results of the election seems stretched at best. In years won by the incumbent party, the Dow declined twice and rose twice. In years won by the challenging party, the Dow picked up gains three times (1976, 1980, 1992) and declined twice (2000, 2008).

One actually informative pattern arises, however. Regardless of what the Dow does before the election, the index has consistently grown very active over the next four weeks. Only in 1976 did the Dow post a change of less than 1% over the next four weeks. On the other hand, the index swung by more than 2% seven times out of nine and more than 4% five times. If nothing else, the data trends toward volatility, not stability, in the weeks directly after an election.

Hold on to your hats
It's important to take this all in context. The 1990s saw the markets hurtling along at a steady beat, so the consistent upswings of the Dow during those years shouldn't be too surprising. Similarly, you should take 2008's statistics in light of the abomination that was the economy that year. The Dow was probably headed lower regardless of who won that election.

Still, while the Dow's temperamental swings through history don't offer a crystal ball as to whether you should buy or sell right now, one thing is clear: The Dow won't sit idly by after this election, and you should prepare now for the swings -- either up or down -- to come. If you're prepared to accept risk in hopes of gleaning a nice, quick payoff, the opportunity looks great to jump in. If you're the cautious investor who doesn't want to play the odds of volatility, it would be best to find a safe haven until after the election buzz has died down.