Investors face election-year uncertainties

By Kevin Fusco

The Daily Record Newswire

Fiscal tensions in Europe, which have been brewing unabated for more than two years, must now also contend with a fresh round of political turmoil that further threatens European Union stability and may serve as a precursor to what most expect to be a heated election year in the United States.

Investors will be watching very closely to see if the uncertainty in Europe and mounting domestic budget concerns will lead to a very recognizable pattern that the equity markets have exhibited over the past five presidential elections.

Recent elections in France and Greece have heightened worries that austerity measures would grind to a halt and that "growth" initiatives would replace them by ushering in new rounds of spending.

World financial markets responded with mixed results to news that newly elected French President François Hollande viewed sharp budget cuts as negotiable, a distinctly different approach from that of the previous administration, which worked with Germany in leadership roles to combat mounting economic and debt concerns.

Although the immediate threats facing Europe are more severe and the likelihood of U.S. debt failure is smaller, the fiscal landscape is eerily similar, and will set the stage for our own elections this November.

Regardless of which candidate wins, the next administration will preside over one of the largest shifts in fiscal policy since the end of World War II. The adage that "the market likes gridlock," or government power divided between the two parties, may not hold true in 2012, as both the markets and investors are expecting action.

Political expectations

Investors' political expectations may also contribute to the equity markets' performance between now and November. After a rather smooth first quarter, April and May have exhibited the volatility that accompanied most of 2011. While it is still too early to know for sure, 2012 may be the next in a line of election years that follow a distinct market pattern.

The pattern is quite simple: The first three quarters of an election year see the S&P 500 trade within a rather constrained band, with a breakout occurring in the fourth quarter, corresponding with the election results.

What is far from simple is the regularity with which the pattern has emerged. The last five election years have exhibited the pattern, although results for investors have been mixed.

In 1992, 1996, and 2004 the fourth quarter breakout was to the upside, while 2000 and 2008 the breakout was decidedly negative. As many will remember, the 2008 fourth-quarter meltdown ended with the S&P 500 falling 37 percent for the year, the worst annual return for the index in decades.

It is important to note though that the pattern, while tied closely to the perceived uncertainty that is resolved at the conclusion of the election, does not favor one political party or the other. Congressional elections that happen concurrently, and shape fiscal policy as well, contribute to expectations and uncertainty.

Historical patterns

Investors who like to use historical patterns as an indication of what might happen again will take solace in the fact that the 2012 election pattern is shaping up to resemble 1996. As previously discussed, the pattern sees the S&P 500 trade in a narrow band in the first three quarters of the year, but this does not mean that index returns are flat.

In 1996 the S&P 500 had already gained more than 10 percent by June before experiencing a slight pullback, which at least to this point, is similar to how the index has performed in 2012. By the end of 1996, and after a stellar breakout in the fourth quarter, the S&P 500 returned more than 20 percent.

It is important to note that this past performance is no guarantee that the pattern will duplicate, but it does illustrate that surprises to the upside are just as possible as the downside moves experienced in 2000 and 2008.

Even though it seems that 2012 has ushered in new and unique variables, such as the political strife in Europe or our own fiscal quagmire, the last five elections years were also fraught with intangibles that the equity markets endured, and hence established this pattern. Patterns in the financial markets such as this are interesting inasmuch that they remain valid until they break, at which time a new one may emerge.

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Kevin Fusco is senior vice president of Fusco Financial Associates Inc. of Towson. He can be reached at 410-296-5400, extension 109, or Kevin.Fusco@LPL.com.

Published: Tue, May 22, 2012