Obama's second year could mean hard times for stocks
By
Dominic Frisby Mar 23, 2010
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Today I want to discuss the 'four-year cycle'. This is a stock-market low that seems to come every four years, in the second year of a US presidency.
That's where we are today. And it seems to affect markets worldwide, not just in the US.
The problem with so many cycles is that an academic will look at historical charts, find a pattern that fits and then arbitrarily call it a cycle. But the four-year cycle has proved a fairly reliable indicator, going back as far as the 19th century.
There are many who use it as part of their trading methodology. So what can it tell us about the markets now?
Four-year cycles – a definite pattern, or just coincidence?
Let me start by demonstrating the cycle to you. You can decide if there is a definite pattern, or if it's just an arbitrary coincidence. This first chart below shows the Dow since 1980. As you can see by the red arrows, there has been a clear, tradable low that has come every four years, in the second year of a US presidential term. That low usually comes in the second half of the year (in October as often as not).
The cycle worked particularly well in 1982, 1990, 1998 and 2002. It did not really work at all in 2006. A lot of traders were waiting for a low in the second half that never came – in fact the low came in May. They were caught out by that rampant bull run in the second half of the year.
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In 1994 the low came early, but boy, was 1994 a year to be buying stocks. Even 1986 worked to a degree, although you would have given it all back in the crash of 1987.
The cycle works earlier in the century too
The following charts show the cycle at work in the earlier part of the century. (These were originally posted by Tim Wood on his website cyclesman.com - thank you Tim.) Here we see the period from 1958 to 1979. Tim has drawn a '4' at the four-year low, in the second year of a presidency. (US elections are held every four years, even in the event of the premature death of a president).
Again the low usually comes in the second half of the year. The cycle worked particularly well throughout this period. In 1978 the low came early, although we got a second, higher low later in the year.
Thanks to Tim again for our next chart which shows the period from 1938 to 1959. I don't agree with his placing of lows of 1949 and 53 , but otherwise the four-year cycle is working well.
This four-year cycle is also apparent in non US-markets, such as the FTSE, for example, and even Japan's Nikkei, as you can see in the chart below. I have drawn arrows to mark the second year of a presidential cycle on the Nikkei over the last 40 years.
With the exception of 1994, when this strategy would have been a disaster, there have consistently been tradable lows in the Nikkei during the second year of a US presidential cycle. In 2002, the low actually came in early 2003, but even so, the next few years enjoyed a sizable rally.
Why does this cycle occur?
If you accept that there is an apparent cycle, you might ask why it occurs. One simple reason– although perhaps too simplistic – is that during a four-year presidency, you'll often see a positive first year accompanying the optimism of a new president.
Then the administration starts doing all the 'bad' things that it thinks need doing, but that make it unpopular. The impact of this is felt in the second year and we head to that four-year low. Then the administration's focus turns to getting itself re-elected, which of course involves being positive and getting market- and economy-friendly. Thus the markets turn back up.
This is all relevant now because we're currently in the second year of a US presidential cycle. Such was the tumult that greeted Obama's first year, it may be that cycle doesn't play out and markets rally from here. But – surprise, surprise – I'm in the bear camp.
The second half of 2010 will be ugly
Technical Analyst Ross Clark of Institutional Advisers writes, 'Beware of the next six months. Midterm presidential years can be ugly. With the exception of the post-WWII boom and 1978, when the market made a 29-month low in March, eight examples failed to surpass the first quarter highs and the remaining eight only managed marginal subsequent gains of 2% to 8% by October. However, 55% of all midterm years suffered declines of 17% to 39% into the July to October period'.
In other words, if history is anything to go by, the second half of this year will be ugly. The chances are that the lows for the year lie ahead of us. What's more we may already have seen the highs for 2010. Buckle up.
Before I go, I'd just like to say thank you for all the comments you post at the end of my articles. It's nice to know that people read what I write and discuss my thoughts. I'm sorry that I don't always have the time to reply, but your comments do get read and considered. So thank you. And when I get things wrong, I am only too glad to be corrected. It's all part of modern 'wiki' culture. I am less keen on mindless internet vitriol, but so far I've pretty much avoided that...
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