The Presidential Cycle: The Only Cycle Worth Following

July 28, 2010

At Cabot, we’re not big fans of anything that aims to predict where the market is going to be months or years down the road. That’s especially true for supposedly “obvious” cycles in the market. One of the most famous—“Sell in May and go away”—does have some merit, but it’s become so well known that sometimes it works … but sometimes it doesn’t.

Others that have followers include timing the market by certain days of week (down Fridays and Mondays are supposed to be a bad sign), time of month (beginning of the month sees cash inflows, and thus, should be better) or by the last number of the year (years ending in 5 have historically done best, etc.). Like most things calendar-related, the track records are mixed, which makes sense—if making money was as easy as looking at the calendar, we’d all be rich!  But unfortunately, that’s not how the market works.

However, Cabot Market Letter Editor Michael Cintolo says there's one cycle with a pristine track record that should be closely watched. In today's issue of Cabot Market Letter, Cintolo writes, "We’re talking about the four-year cycle, sometimes referred to as the Presidential cycle. Specifically, there is one portion of this cycle that has stood the test of time: From the market’s low point in the year of the mid-term elections (like 2010), to its high the following year (2011), the major averages have averaged a gain of nearly 50%. It’s true!"

"If you have a sense of market history, it won’t take long to realize how profitable this cycle has been. For instance, 1990 provided a major low in October, just before the first Gulf War began, and 1991 was a boom year. After a flat 1994, the market mushroomed in 1995, kicking off a multi-year bull trend. And we all remember the late-1998 and 1999 melt-up!  Even in the two mid-term election cycles since the popping of the Internet bubble, the 2003 and 2007 rallies provided terrific opportunities for growth investors.

"And perhaps that last point is the most important—regardless of the exact size and duration of the rally, for whatever reason, leading stocks have put on tremendous shows during pre-Presidential election years. Many of our Model Portfolio’s best performances have been in these years (1991, 1995, 1999, 2003, 2007, etc.), regardless of how high the indexes had risen. For instance, the S&P 500 was up less than 4% in 2007, the weakest cycle rally in 30 years. Yet the Model Portfolio was up more than 30% as growth stocks like Crocs (CROX), Research in Motion (RIMM) and First Solar (FSLR), along with momentum favorites like DryShips (DRYS) and Potash Corp. (POT), soared to the skies.

"Why does the four-year cycle work when so many other cycles have spotty histories? We think it’s because the cycle is rooted in fact—Presidents and Congresses are much more likely to open up the spigots heading into a Presidential election year. Oftentimes, too, mid-term elections tend to balance power; divided governments have historically interfered less and produced better market returns. Also, in terms of market psychology, it’s good that the cycle isn’t overly specific; it doesn’t tell you the bottom will occur October 13 and then peak the next year on August 4. It’s more of a broad guide based on political realities, and the record itself is consistent and lucrative.

"So where does that leave us now? Well, the real question is whether the market has hit its low for the year; with a Dow low of 9,687, a rally into 2011 could carry the index well above 13,000 and even to 14,000. It might sound crazy, but history suggests it’s not just possible, but likely!  

"Of course, there’s always a chance that stocks have not hit their low for the year; maybe another leg down will develop, taking the Dow down to 9,000 or below. However, the main point is that looking out over the next 12 to 15 months, it’s highly likely there will be a great bull run. Thus, no matter what comes, keep your head up—there are likely to be some big winners lifting off in the weeks and months to come."

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