THE FOUR-YEAR PRESIDENTIAL CYCLE SUGGESTS THAT 2014 COULD SUFFER A MAJOR DOWNSIDE CORRECTION -- THE GOOD NEWS IS THAT A MAJOR BUYING OPPORTUNITY IS LIKELY LATER IN THE YEAR -- THE STRONGEST THREE MONTH PERIOD ENDS IN JANUARY
SECOND YEAR OF PRESIDENTIAL TERM IS USUALLY THE WORST ... Those of you who have read my messages over the last year know that I am bullish on the long-term direction of the stock market. I believe that the "secular" bear market that started in 2000 ended this year when the S&P 500 broke out of a decade-long trading range to hit a new record. I also believe that a major rotation out of bonds and into stocks is now underway which should make stocks a much better investment than bonds for several years. Within that longer term secular uptrend, however, the stock market is not immune from sharp downside corrections, or even bear markets. The current bull market started in March 2009 and is now in its fifth year. That's unusually long for any bull market to go without a major setback. In my view, that makes the coming year (2014) especially dangerous. That's especially true considering that it's also the second year of the presidential cycle and a midterm election year. Which brings us to the four-year presidential cycle. An average U.S. business cycle lasts four years, which happens to also coincide with a four-year presidential term. As a result, it's often called the presidential cycle. According to the Stock Traders Almanac, the two first years of the four-year cycle are usually the worst with the last two usually the best. Bear markets usually occur during the first two years. Since 2013 (the first year of this term) was so strong, historical odds for 2014 (the second year) to suffer a downside correction are pretty high.
(click to view a live version of this chart)
Chart 1
THE HISTORY OF THE THE FOUR-YEAR CYCLE... Chart 1 overlays four-year cycle lows on the S&P 500 going back to 1990. The vertical bars show the last six bottoms occurring in 1990, 1994, 1998, 2002, 2006, and 2010. Earlier four-year patterns (not shown here) occurred in 1970, 1974, 1982, and 1987 (the cycle skipped 1978 while 1987 was a year late). Most of those bottoms took place during the second half of those years (mainly around October), and have coincided with midterm congressional elections. Assuming the four-year pattern repeats, the next bottom is due in 2014 and most likely during the fourth quarter. That carries both good and bad news. While the second year of a presidential term (like 2014) is usually the weakest, the third year (2015) is usually the strongest. The bad news is that 2014 is likely to experience a major stock correction. The good news is that correction should lead to a major buying buying opportunity later in the year.
EXAMPLES OF LAST FOUR BOTTOMS... The next four charts show when the peaks and troughs took place during the last four midterm election years. Price peaks took place in April, May, March, and July. Final bottoms took place in August, July, and the last two in October. Going back historically, most tops have tended to take place in the spring and most bottoms in October. Losses averaged 20% during the four years shown here and corrections averaged five months in length. [According to Ned Davis Research, mid-term election years since 1934 have suffered losses averaging 21%]. Which brings us to a couple of short-term seasonal patterns to take into consideration in preparation for the coming year. Those seasonal patterns may offer some clues about when to exit or enter the market next year. The first is the "best three month period". Stock Traders Almanac ranks the strongest and weakest months of the year for the S&P 500 since 1950. The strongest five months of the year (in descending order) are December, April, November, January, and March. According to the Alamanc, the strongest three month period during the year is November through January. Which brings us to our first thought for 2014. January is the first opportunity of the new year to do some selling following a three-month period of seasonal strength. A second opportunity to lighten up takes place during the spring. April is usually the second strongest month of the year (March is fifth). Seasonal patterns start to weaken in May.
(click to view a live version of this chart)
Chart 2
(click to view a live version of this chart)
Chart 3
(click to view a live version of this chart)
Chart 4
(click to view a live version of this chart)
Chart 5
BEST SIX MONTH PERIOD ENDS IN APRIL... The Stock Traders Almanac divides the year into two halves based on historic seasonal tendencies. Generally speaking, the "strongest six months of the year" occur between November 1 and April 30. That's usually the best time to be in the market. The weakest six months are between May 1 and October 30. That's usually the best time to be in a more defensive posture. [Hence the "sell in May" slogan]. For our purposes here, that suggests that the second opportunity to lighten up in stocks would come during April. Assuming the market follows its normal seasonal pattern in 2014, that would also suggest getting back into stocks next November (hopefully after an October bottom). The tendency for stocks to peak in the spring and bottom during the fourth quarter are more pronounced in mid-term election years (which include 2014). March 2014 will be the fifth anniversary of the March 2009 bottom. A five-year bull market is usually in need of a correction. It may also be worth noting that next March is when most economists believe Fed tapering will begin (if not sooner). That might be enough to trigger a spring correction.
NYSE COMPOSITE INDEX IS TESTING ITS 2007 HIGH... The monthly bars in Chart 6 show the NYSE Composite Index testing its 2007 high. And it's doing so in an overbought condition. That's shown by the 14-month RSI line (above chart) recently trading above 70. The good news is that the monthly MACD lines (below chart) are still positive. Most other major market indexes are also in overbought territory. That's not necessarily a bad thing, especially during periods of seasonal strength. That seasonal strength, however, will start to weaken in the new year. So will the historical record for the four-year presidential cycle which favors a major correction next year -- most likely in the spring if not sooner. Please keep in mind that these are seasonal tendencies. We still have to use technical indicators to spot important turns in the market. The best approach is to be aware of these historical patterns, but to use market charts to fine-tune entry and exit points.
(click to view a live version of this chart)
Chart 6
SHORT-TERM S&P TREND WEAKENS... The daily bars in Chart 7 show short-term weakness in the S&P 500. Not only has it slipped below its early December low, but daily MACD lines (above chart) have remained negative all month. The market appears to be a short-term tug-of-war between a strong December seasonal pattern (the Santa Claus rally is concentrated in the second half of December, and the last week of the year in particular) and short-term concerns about a surprise decision by the Fed next Wednesday. Some money managers and investors may also be lightening up a bit early this year to protect 2013 winnings. So far, the market pullback has been relatively small. The S&P would have to close below its early November low at 1746 and, more importantly, its September peak (1729) to raise more serious alarms. The weekly bars of the S&P 500 in Chart 8 offer more perspective. The 14-month RSI line (top of chart) is in overbought territory. The weekly MACD lines are stalling, but remain positive. They would have to turn negative to raise concerns about a downside correction. The last correction the market suffered was during 2011. The S&P peaked that year in late April and lost 19% before bottoming in October. Although 2011 wasn't a midterm election year, it might be worth keeping that year in mind as a possible blueprint for 2014.
(click to view a live version of this chart)
Chart 7
