Seasonal Timing and a Sinister Sub-Cycle

09/29/2014 10:00 am EST

Focus: STRATEGIES

Sy Harding, editor of Street Smart Report, suggests that a market correction now may be more favorable than a continued advance when you compare the present presidential cycle historically to the second terms of previous two-term presidents.

Steven Halpern:  Joining us today is Sy Harding, one of the best-known and top-ranked market timers and editor of Street Smart Report.  How are you doing, Sy?  
Sy Harding:  Well, I’m just doing fine, Steven.  How are you?  

Steven Halpern:  Very good.  Thank you so much for taking the time to join us today.  Obviously, you’re never hoping for a bad market—or for economic trouble—but in your latest research, you suggest that a market correction now could be much more favorable than a continued advance.  Could you help explain this?  

Sy Harding:  Well, Steven, by most measurements, the market is at least fully valued, and by several measurements, it’s significantly overvalued.  It has also gone for an unusual length of time without even a normal 10% to 15% correction.  
As it keeps rising without a correction to cool off the valuations and the extreme bullish investor sentiment, it’s approaching bubble conditions.  A normal correction of 10% to 15% now would therefore be more beneficial for the longer-term than continuously higher prices.  

The higher the market goes without a correction, the higher the odds become that when a correction does arrive, it will more resemble a serious bursting of a bubble than a normal correction.  

Steven Halpern:  Now, you’re well known as an expert on market cycles and patterns, and one of the patterns that you follow closely is the four-year presidential cycle, but particularly relevant now is something you call a sinister sub-pattern within the presidential cycle.  Could you explain what you mean?  

Sy Harding:  Sure, the four-year presidential cycle has a well-documented history.  Each new president tends to allow any imbalances between the economy and the stock market to take place in the first two years of his administration.  

Typically, the administration then makes every effort in the third and fourth years to make sure the economy and market are strong again when reelection time rolls around.  

The result is that the market often has a significant correction in the first two years of the four-year presidential cycle and is then particularly strong in that third and fourth year.  

However, there’s a little-known sub-pattern.  The pattern changes when an administration is in its second term, unable to be elected again. They seem to have less interest in the next election.  

Administrations in a second term tend to try to keep the economy and stock market growing, not only through the last two years of their first term, but all the way through the four years of their second term.  

That does not usually work out well since it raises the risk of having the market even more overheated and overvalued in the third and fourth year of their second term.  Unfortunately, that is the situation we are potentially in now.  

The Obama Administration is in its second term and, so far, has not had a correction in the first two years of the term.  Can it expect to keep the market rising for the next two years—and that is all the way through to the end of the second term?  The odds are against that happening without a correction first to cool off the excess.  

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Steven Halpern:  Now, in your latest research, you also review the last three times we saw this sub-pattern of presidential second terms.  Could you briefly highlight what happened on those previous occasions?  

Sy Harding:  Well, the last three presidents to serve two terms were Presidents Reagan, Clinton, and George Bush, Jr.  All three experienced corrections in the first or second year of their first term and strong markets in the last two years of their first term.  

However, after being reelected to second terms, their administrations did not allow a typical cooling off or correction in the first two years of their second term. Instead, they struggled to keep the strong economy and market of the last two years of their first term going for another four years, all the way to the end of their second term.  In all three cases, the result was not good.  

The 1987 crash took place in the third year of President Reagan’s second term. The 2000/2002 bear market began in the beginning of the fourth year of President Clinton’s second term, and the 2007/2009 bear market began in the third year of President Bush Jr.’s second term.  

So far, the Obama Administration, reelected to a second term, is following that same sub-pattern within the four-year presidential cycle.  So far, it has not had a cooling off correction in the first two years of the second term.  

If it doesn’t, that will not bode well for the third and fourth year of the term.  That sub-pattern is another reason why I believe a correction now would be more beneficial for the longer term than continuously higher prices now.  

Steven Halpern:  Now, another seasonal pattern that you follow is the tendency for the stock market to be weak between May and October with a stronger tendency during the six months beginning in November.  So far, this year, stocks have moved counter to that seasonal pattern.  Could you help reconcile the seasonal pattern with the election cycle?  

Sy Harding:  Well, the ‘Sell in May and Go Away’ pattern is that the market tends to make most of its annual gains each year between November 1 and May 1, and experiences most of its corrections between May 1 and November 1. It’s been verified by many academic studies, but it does not work out that way every year.  

Sometimes—like last year and this year, so far—there’s no correction in the unfavorable season, but the pattern is so consistent that, over the long-term, moving to cash on May 1and reentering on November 1 significantly outperforms the market while taking only 50% of market risk.

However, since the market does not begin a favorable season rally exactly on November 1 each year, at Street Smart Report we have a modification of the strategy.  It utilizes a technical indicator to better pinpoint the exit in the spring and the reentry in the fall.  

Our version allows for reentry as early as October 16, or as late as late November, and so it’s been used in our newsletter since 1999.  Hulbert Financial Digest verifies that it significantly outperforms the market and the ‘Sell in May’ strategy.  

By either strategy, the market still has time for a significant correction before the reentry signal is triggered and I do believe a correction now would be more beneficial for the longer-term than continuously higher prices and I believe that all these things are pointing to the importance that there would be, if we could have a correction now.  

Steven Halpern:  Well, we really appreciate you taking the time, today.  That’s fascinating information. Thank you, again.  

Sy Harding:  You’re more than welcome.  

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