Birchtree,
Thought you might like this article from Ned Davis....
Ned Davis is one of the most reasonable voices on Wall Street. Following article courtesy of Smart Money is a must-read:
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Vote of No Confidence
By Lisa Scherzer
September 7, 2006
HISTORY SHOWS THAT reducing or increasing stock exposure based on the presidential cycle can be a prudent financial move. The technical gurus at Ned Davis Research analyzed data going all the way back to 1888, when Benjamin Harrison was elected to the White House, to quantify this connection between market performance and the four-year election cycle. The results are telling.
According to the findings, Ned Davis, president and senior investment strategist at the Venice, Fla., research firm, says the S&P 500 index saw an average increase of 8.4% in the year of a presidential election. In a pre-election year stocks averaged an even better 11.0% gain. Further, there hasn't been a down pre-election year since the 1940s, says Davis. This trend bodes well for 2007. Davis attributes the pattern to the timing of government stimulus. He theorizes that politicians do everything in their power to perk up the economy during campaign season as voters are deciding who to vote for at the polls.
Stocks performance in midterm election years, like we're in now, is a different story. The market rose an average of 3.3% during these periods, but about half the time stocks finished midterm election years in the red. Even less encouraging for investors right now is the fact that of the 16 quarters of a four-year presidential term, the least favorable for stocks has been the third quarter of the midterm election year.
"September should be the worst month of the year, but I don't think the evidence is that negative," says Davis.
Despite the historical evidence — remember, September and October tend in general to be lousy months for stocks regardless of the election cycle — Davis thinks this fall won't be as bad as usual. His rationale: The series of calamities that struck earlier this year including the India train bombing and the spoiled London terror plot have already taken some steam out of equities.
SmartMoney.com: What's the connection between elections and stock-market performance?
Ned Davis: There seems to be a four-year cycle in stock prices. Some people say the cycle is related to the economy. Another view — a more cynical one — is that as the presidential elections and elections in general get closer, the party in power wants the economy to be doing well. So there's a big incentive, a year before the election, to try to get the economy to do well. The tendency in both parties is to sweep problems under the rug. After an election, you've overstimulated the economy, you have inflation and a lack of resources; the problems come back out now. The first two years after an election the market is on the defensive because of the uncertainty of cleaning the mess up from the stimulus. That's the theory behind the presidential election cycle.
A few weeks before an election, since no one knows for certain how it's going to turn out, usually the market backs off a bit. After the elections, the market almost always rallies. The theory behind that is the majority, by definition, is happy with the result. Or another explanation is you're not dealing with uncertainty anymore. The market has a hard time with uncertainty. After the elections there's usually a pretty good rally.
SM: How has this pattern played out over the years?
ND: Going back to 1888, the [market in] the average presidential election year was up 73% of the time, and the average gain for that year was 8.4%. Our last presidential election year, 2004, the market was up 9%, so that's right in line with the averages. Historically, the post-election year was up 57% of the time, and the average gain is 2.9%. Last year it was up 3%. The market in the midterm election year was up 55% of the time, and the average gain was 3.3%. The pre-election year was up 79% of the time. There has not been a down pre-election year since the 1940s. And the average gain was 11%.
Now we're in a midterm year, which has been up 55% of the time and has a small gain for that year. I think it was playing out very close to the cycle. Generally the year starts out rocky; one leg down in May and June and another leg down into the fall. This year it may have been short-circuited somewhat. First of all, the presidential election cycle theory has gotten a lot more popular, people have gotten in line with it. That's why the rules change on Wall Street. Once something gets popular, it no longer works. We had a scary May-June selloff. Then we had that huge bombing in India that killed nearly 200 people. Then we had the war in Lebanon. Everybody was scared it would spread to Iran. Then the terror plot in London. These events cause a short-term selloff. Subsequently, there's sort of a vacuum of negative sentiment. September is generally one of the worst months of year for stock market performance. All these negatives hit earlier this year has taken away some of that [selloff tendency]. I'm not sure it's going to play out like normal. It may not be such a weak September and October.
SM: Did you find any correlation between the political party in power and market performance?
ND: We found that no matter if there was a Democratic president and a Republican Congress, or a Republican president and a Democratic Congress, the market did better under gridlock than if there were both a Democratic president and Congress or Republican president and Congress.... It might seem like it would be difficult to get anything done when you have gridlock. But the market does better under gridlock than when one party controls both branches. Perhaps people think no radical programs are going to take place, nothing major will happen, which gives some sense of assurance.
The data go back a long way. When you look back at presidents where the market did best, like Eisenhower and Clinton, it seems that the market likes a caretaker president. Eisenhower was Republican but Democrats controlled Congress. With Clinton, Republicans controlled the Congress. I think if the Democrats were to win at least the House this fall, which seems likely, there may be some uncertainty going into that, but really the markets may like it, because it's sort of another check and balance.
SM: According to the election cycle theory, of the 16 fiscal quarters in the four-year presidential term, the least favorable quarter for stocks is the third quarter of the midterm election year, which we are in now.
ND: We had, whether it was coincidence or not, a bad economy coming out of the 2001 recession. The economy did really well last year and the market did reasonably well. This year the Fed continued to tighten interest rates, tax revenues have shot up — in a way that's a restrictive measure. It does seem to be that we ran into some inflation problems because we overstimulated, and now we're paying the price. The places we can see that is in housing and autos — usually that's where you see it — because they're so credit-dependent. Some people think the economy is going to slow enough next year where the Fed might lower rates.
Next year is a pre-presidential year, so you would expect stimulus. If the theory goes, next year is likely to see the Fed cutting rates again. The record shows that the Fed starts cutting rates six months after the latest rate hike. I'm guessing that would be early next year.
SM: How does this research factor into traditional economic/market cycle predictions that say we're near the end of a bull market?
ND: The patterns are useful if they agree with the indicator evidence.... Last year we had a more mixed market. Lately I think all these negatives caused a lot of selling to get out of the way. When I'm giving advice, I'm more likely to look at indicators rather than where we are in the cycle. Sometimes they give you a roadmap. But I don't think they're useful if they're much different than what the indicators tell you. I don't think the indicator evidence is bearish now. September should be the worst month of the year, but I don't think the evidence is that negative. I'm doubting we'll have much of a pullback. All these crises — even 9/11 — generally have little lasting impact on the stock market. Within three months, all markets are at new highs after almost every crisis.
