James Pethokoukis

A bit more from Ed Yardeni on one of my favorite topics:

Yesterday, I reviewed the outstanding performance of the market three months after midterm elections. I also noted that the third years of the presidential cycle tend to be very bullish. The fourth year of presidential terms, along with first and second years, tend to be much less consistently bullish than third years.

Yesterday, I asked Joe, “How well does the S&P 500 perform from the midterm elections to the end of the third year of the President’s term?” The results are spectacular. Since 1962, there have been 12 such 14-month periods, and their average increase was 20.9%! Not one of them was down. Indeed, there are only two gains that are not in the double digits: 0.4% during 1986-1987 and 6.2% during 2006-2007. …  I suppose it could be different this time. Gridlock might block appropriate policy responses to revive economic growth, if necessary. Gridlock might mean that the Bush tax cuts won’t be extended for another year to avoid depressing a depressing recovery. Gridlock could stymie any agreement on measures necessary to narrow the federal deficit. Then again, a sweeping ouster of incumbents on November 2 might be a good start toward bringing back some fiscal discipline in Washington by newly elected legislators, who really want to do what’s good for the country rather than for themselves.

Me:  Gridlock is better than another wave of tax hikes and regulation — but not as good as spending cuts and pro-growth policies like cutting taxes on companies and capital.

The always insightful and interesting Ed Yardeni gathers some numbers on elections and market returns:

So what do stocks do just before and just after midterm elections and in the third year of the Presidential Cycle? They usually go up, and by quite a lot. Let’s review:

(1) According to my friend Laszlo Birinyi and former colleague at Deutsche Bank, in the 12 midterm election years going back to 1962, the S&P 500 has on average risen 2.4% in the two months prior to the election and gained 7.5% in the three months following. The only post-election downer was during 2002, when the Republicans under George W. Bush retook the Senate and held on to their slight majority in the House. The biggest gain was 14.6% during 1998 (under Clinton) and the smallest gain was 3.3% during 1994 when the Democrats under Bill Clinton lost both the House and Senate.

(2) According to Deutsche Bank chief U.S. equities strategist Binky Chadha, the S&P 500 has produced gains in 18 out of the last 19 midterm election cycles. The S&P has returned an average of 13% in the six months after midterm elections, and 17% over the next 12 months. The indicator works regardless of which party wins control of Congress, but it’s especially strong when there is a Democratic president and Republican legislature. When that scenario is in place, stocks average 14.6% annual returns, according to Bill Stone, chief investment strategist at PNC Wealth Management. “It’s the best of all iterations,” he says.

(3) The DJIA has risen 24 times and fallen 5 times in the 29 third calendar years of the Presidential Cycle since 1891. The overall, average gain for the 29 third calendar years is 12.31%, with the 16 Republican presidencies averaging gains of 5.12% and the 13 Democratic presidencies averaging gains of 21.14%.

(4) Joe analyzed the four-year Presidential Cycle of the S&P 500 since 1952. He found that this index increased on average by 4.4% during the first year, 4.8% during the second, 18.4% during the third, and 5.7% during the fourth. Excluding second terms of reelected Presidents, he found that the first term of all of them since 1952 averaged 3.2% during the first year, 2.2% during the second year, 21.6% during the third year, and 11.5% during the fourth year. In other words, third years tend to be the best ones, and have been up years during every Presidential Cycle since 1955.

While the historical record suggests that the stock market is likely to do very well over the rest of this year, and even better next year, might it be different this time? I’ll discuss this possibility tomorrow.

Me: This also plays into the “gridlock into good” mantra. And certainly there should be less anti-market legislation in the second half of Obama’s term than the first half. But the U.S. does have real problems that need attending to — budget reform and tax reform, in particular.

All year I have been saying a great way to boost the economy is to boost the stock market. Make it easier to raise capital and restores net worth. Now Alan Greenspan is saying the same thing:

“The stimulus is only a third spent, and its order of magnitude is not large enough to compare with the strength and power of the remarkable global equity increase that’s occurred since early March,” Greenspan, 83, said in a telephone interview yesterday from Washington. “Capital gains have proved a far greater stimulus than one can attribute to the $787 billion program that has been only partially spent.”

Fellow Reuters columnist Agnes Crane see trouble ahead:

Turn the calendar to September and markets are fixated about potential problems at the banks again. The obsession with September being a bad month for stocks and for the world in general has nothing to do with it, I’m sure.

I’m certainly the last person to downplay the still tough road ahead given the state of the U.S. consumer, commercial real estate and the excesses that still need to be wrung out of the system, but the fickle trading, especially in the stock market this summer, has made it difficult to read too much into the daily moves.

The most obvious way to predict a stock market crash is to find out when I go all in. But there may be another, says New Scientist:

Now a team of physicists and financiers have bucked the trend by successfully predicting a steep fall in the Shanghai Stock Exchange. …  The idea is that if a plot of the logarithm of the market’s value over time deviates upwards from a straight line, it’s a clear warning that people are investing simply because the market is rising rather than paying heed to the intrinsic worth of companies. By projecting the trend, the team can predict when growth will become unsustainable and the market will crash.

Sornette, Zhou and colleagues applied their model to the Shanghai Composite Index, which tracks the combined worth of all companies listed on the Shanghai Stock Exchange, the world’s second largest. Early this year, the index gained 50 per cent in just four months. In July, the team predicted that the index would start to fall sharply by 10 August. The index duly began to slide on 4 August, falling almost 20 per cent in the subsequent two weeks.

Me: I assume this would also work with individual stocks. Econophysicist Didier Sornette has a paper that puts his approach in a bit more context.