Will 2016 Be a Good Year for Stocks?

Will 2016 Be a Good Year for Stocks?

Will 2016 be good for stocks? It's more than likely the market will do well, if you believe the so-called "presidential stock cycle" theory will continue to hold. But that's the rub – because while history shows the odds will be in your favor if you follow it, it doesn't always work.

Since 1946, the stock market has risen 76 percent of the time in the final year of a president's four-year term, with the Standard & Poor's 500 index rallying 6.1 percent on average, according to an analysis provided by S&P Capital IQ to U.S. News & World Report.

The data covers the seven-decade period from Dec. 31, 1945 through this year. If an incumbent is re-elected at the end of the four-year term, then the cycle starts again at year one – so 2016 is the fourth year in the second term of President Barack Obama.

The presidential cycle isn't just market voodoo; there are actually some solid fundamentals behind the idea that the politics of electioneering affects the real economy. Incumbents have an incentive to do what is necessary to boost the economy, including increased government spending or tax cuts, to sway favor with voters.

"The theory is that going into the election, the presidents are paving the way for their success in the election," says Bill Stone, chief investment strategist at PNC Asset Management Group.

The improved economy ultimately leads to better profits for companies and it is those increased earnings that drive stock prices higher.

Likewise, when an election is over, the winners often opt to "swallow some bitter pills in the first two years," Stone says. Such necessary but harsh economic medicine might include spending cuts and increased taxes. That fits with the data from S&P Capital IQ, which shows the S&P 500 rising only 61 percent of the time in those first two years in the cycle, with average gains of 7.6 percent and 5.7 percent, respectively. The best year is the third year, when the index rallies 88 percent of the time for average gains of 16.1 percent.

That said, it's also clear the stock market cycle research doesn't work every time. There aren't many data points because there haven't been many presidents – the republic is still young.

In any cycle, returns may not conform to patterns of the past. But in this cycle there is an even stronger argument for doubting that anything is normal. That's in part because until quite recently the economy was still feeling the effects of the financial crisis. It's still unclear if the markets will post a gain for 2015.

If anything, the cycle is backward, with the Federal Reserve set to start increasing interest rates during the run-up to the 2016 elections. "It does make sense to question whether this cycle is much like the typical," Stone says. "We are just now in the process of taking the stimulus away."

Steve Wood, chief market strategist at Russell Investments, says the speed at which the Fed raises rates will be the key driver of the stock market in 2016. The faster it does, the less happy investors will likely be.

Other factors that could depress markets would be a conflict between the U.S. and China over navigation rights in the South China Sea or an economic crisis in a large emerging market, such as South Africa, Turkey or Brazil, Wood says.

Scott Colyer, CEO of Advisors Asset Management in Colorado Springs, Colorado, anticipates market gains in 2016, but not necessarily because of U.S. election-related activities. "We expect to see growth in Europe next year," he says, referring to efforts by the European Central Bank to boost the flagging economy there.

That could mean better earnings for large multinationals, such as some of the companies in the S&P 500. A good rule of thumb is that half of earnings for those companies comes from outside the U.S., so good growth in foreign earnings would help.