The Past Happens Over And Over Again!

Being Street Smart: The Past Happens Over And Over Again!
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By Sy Harding | 25 July 2008

As Paul Harvey once said, "In times like these it helps to recall that there have always been times like these."

Yet the world hardly ever comes to an end. The future arrives. The cycles continue. Sunny weather still follows stormy weather, winter still follows summer, spring still follows winter— every time. For investors there’s nothing more important than recognizing that business, the economy, and markets also move in cycles, not endless straight lines. Recessions follow boom times, bear markets follow bull markets, bull markets follow bear markets— every time.

There are two cycles, one of intermediate-term duration, the other longer-term, which can be of significant importance to investors. The first is the annual seasonal cycle. It has been proved beyond doubt (through 60 years of back-testing, and nine years now in real-time) [[academic studies have detected this tendency as far back as the early 17th century in English records, and in 34 of 36 countries, currently— but, unmodified by Sy's use of the MACD, it is too weak to trade: normxxx]], that the stock market makes most of its gains each year in a winter and spring favorable season, and suffers by far the majority of its corrections, crashes, and bear markets in its unfavorable summer months [[and, especially, in the months seperating the two periods: normxxx]]. I refer to the Seasonal Timing Strategy I introduced in 1999’s Riding the Bear— How to Prosper in the Coming Bear Market [[still a GREAT read, if you can get hold of a copy: normxxx]].

Over the nine years since, its total return has been more than double that of the Dow, and triple that of the money-manager’s ‘benchmark’ S&P 500. The details are on my Street Smart Report website (see above link), and in my books. But I want to use this column to discuss the longer-term cycle, since I expect it will be of more importance than usual over the next few years.

It is the Four-Year Presidential Cycle. Its history is extremely consistent. The economy and stock market tend to have serious problems in the first two years of each new presidential term, and then to be recovered and strong in the final two years of the term.

What causes the pattern? It’s clear in the history that each Administration takes heroic steps in the 2nd and 3rd year of its term to make sure the economy is strong by the time re-election time comes around. The efforts typically include higher government spending, lower interest rates, and even economic stimulus plans if necessary.

The problem is that almost always by re-election time that excessive stoking of the economic fires has created excesses, including over-priced stocks. Those excesses are then allowed to correct in the first two years of the next term, and then the cycle is repeated. Thus the historically consistent cycle takes place, of economic and market problems in the first two years of each new presidential term, followed by boom times in the final two years of each term.

History also shows that the pattern does not often occur when a president is serving his second and final term, (perhaps because his administration’s interest in the next election is not as great). For instance, no economic or market corrections took place in the first two years of the second terms of Reagan, Clinton, or Bush. (Because the excesses are not corrected in the first two years of second terms, the problems tend to come later in the term. For Reagan it was the 1987 crash in the 3rd year of his second term. For Clinton the 2000-2002 bear market began in the 4th year of his second term. For President Bush, the current bear market began last October, the 3rd year of his second term).

However, for first terms, the pattern of significant lows in the 2nd year of each term is so powerful that since at least 1918, even the conservative Dow has experienced a super rally from the low in the 2nd year to the high in the following year, its average gain in those rallies being 50%.

Now consider that no matter which candidate is elected in November, the next four-year presidential cycle will be that of a new first-term president. Then consider the conditions his administration will inherit and the likelihood they will not be solved in the first year of the term. The largest budget deficit ever, a record trade deficit, an expensive war that both candidates expect will continue well into 2010, still rising home foreclosures, an economy likely to be in recession, and so on.

Therefore, the Four-Year Presidential Cycle has me expecting the current bear market will not see its final low until sometime in 2010, the 2nd year of the next administration.

In the meantime, the annual seasonal pattern has me expecting there will be significant bear market rallies and corrections from which to make substantial profits until then. In the 2000-2002 bear market there were several bear market rallies in which the S&P 500 gained more than 20%. The Nasdaq experienced three bear market rallies, in each of which it gained more than 40%, each followed by an even larger decline.

If I am right in my expectations, buy and hold investors are likely to continue to be disappointed over the next two years, while opportunities should be exceptional for those willing to go after gains from both the upside in the bear market rallies, and from the downside when the rallies end and the next down-leg in a continuing bear market takes place.

Sy Harding publishes the financial website Street Smart Report Online, and a free morning blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear— How To Prosper In the Coming Bear Market. His latest book is Beating the Market the Easy Way— Surprising Seasonal Strategies that Double the Market's Performance.

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  M O R E. . .

Normxxx    
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