12.31.09
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12.31.09 Except for the final day of the year, the market experienced a typical positive period in advance of and during the holidays. But as usual it was on extremely light volume, with an estimated 40% of professional traders and institutional investors absent (for their usual winter vacations during the holiday periods when not much is going on). They will be straggling back during the week next week, and markets are anxiously awaiting indications of their plans for the beginning of the new year. The anxiety is heightened this year because the last two Januaries have been quite ugly. And the first trading day of January may not be all that indicative. The first day of January in the year just past saw a huge rally on the first trading day of the year, with the Dow up 258 points, which was then 2.8%. But that one day was the end of positive action until early March, by which time the market had experienced a 25% mini-crash. Conditions are certainly different this year. Last January the financial system was on the brink of total collapse, the economy on the brink of falling off a cliff into a Depression, and corporate earnings expected to plunge sharply. This year the economy is in a recovery, at least the large banks have been rescued and are profitable, and earnings for the 4th quarter, which will begin being released next week, are expected not only to be fairly strong, but will have easier comparisons to the big declines of a year ago. But there are other concerns this year, as witnessed by the jittery market on the last day of the year. The concerns come from opposite directions. From one direction comes the expectation that the Fed will be removing the punch bowl of easy money as the economy continues to recover, and raising interest rates sometime this year. The market abhors rising interest rates. From the opposite direction comes concerns that the economy will drop back into recession for a couple of quarters once the stimulus efforts like bonuses to home-buyers expire. Both recognize that the market anticipates conditions six to nine months in advance. So 2010 is not likely to be the easy one-directional market everyone is hoping for. There will surely be volatility and opportunities from both directions during the year The history of the Presidential Cycle is that the economy and stock market tend to have problems in the first two years of each new president’s term, and then recover and be robust over the last two years of the term. The cycle has a very consistent pattern. For instance, almost all bear markets have taken place in the first two years of the presidential cycle, and almost all recoveries have been underway in the last two years of the cycle. The pattern is not consistent when a president is in his second term, perhaps because he cannot be re-elected. For instance, the pattern was clearly evident in Reagan’s, Clinton’s, and Bush Jr’s first terms. But normal corrections were not allowed to take place in the first two years of their second terms, the economy and market just kept on going. That allowed the excesses to become more serious. So the 1987 crash took place in the third year of Reagan’s second term, the 2000-2002 bear market began in the fourth year of Clinton’s second term, and the recent 2007-2009 bear market began in the fourth year of Bush’s second term. So what does that mean for next year, when we have a president in his first term, and next year will be the second year in this presidential cycle? There will still be economic problems, in the real estate sector when the program of big tax rebates to home buyers expires in the spring, in the financial sector as commercial loan defaults continue to spike, in consumer spending (75% of the economy) as consumers remain hunkered down under high debt levels and high unemployment. No one expects any more than tepid economic growth next year. There may even be a dip back into recession for a quarter or two. Of the seven recessions since 1957, five had W bottoms rather than V bottoms. That is, they experienced one or two positive quarters and then dropped back into recession for one or two quarters. So between annual seasonality patterns probably returning, and economic problems not having gone completely away, and next year being the 2nd year of the presidential cycle, we can expect problems sometime during the year for the stock market. However, there is something else - a big positive. The most consistent market pattern we have ever encountered is that since at least 1918 there has been a substantial rally from the low in the second year of every Presidential term to the high the following year. That is so whether it was a president’s first or second term. Even the conservative Dow gained an average of 50% in those rallies. It has taken place no matter which political party was in office, in periods of war or peace, high or low interest rates, high or low inflation, high or low budget deficits, or whatever. In fact the market makes most of its long-term gains in the period from the low in the second year of the presidential cycle through the following election year. It’s a period when you would not want to be out of the market, a period when even buy and hold investing is at its best. The problem is in getting safely to that low. Historically, it has more often taken place in the fall, but over the years every month has had a turn or two in producing the low, even January. So, it is highly likely there will be an important time next year to take profits and stand aside, to avoid the large losses that have taken place within each year recently. But also a time to buy with both hands, to even use margin and leverage. But it will be tricky to identify those key turning points. The problem is not made easier by the fact that each of the last two years experienced serious downturns right out of the gate, beginning just a few days into January. WE are still 100% in CASH, but may be making a move soon. Till next time The MTA Staff |
