Market Myths and Complacency

03/18/2015 10:00 am EST

Focus: STOCKS

Market timer Sy Harding thinks investors are overly confident in two market myths; one, that the Federal Reserve can continually support higher stock prices and two, that the third year of the Presidential cycle portends market gains. Here, the editor of Street Smart Report looks below the surface of these two assertions.

Steven Halpern:  Joining us today is Sy Harding, a top-ranked market timing expert and editor of Street Smart Report. How are you doing today, Sy?

Sy Harding:  Well, I’m doing just fine, Steven, how are you?

Steven Halpern:  Very good. Thank you for joining us.  Many on Wall Street are convinced that the Federal Reserve’s actions will keep supporting ongoing rise in stock prices. You’re not as confident and are growing concerned over this complacency. Could you explain your concerns?

Sy Harding:  Well, Steven, I think investors are probably too complacent regarding the prospects for 2015 and seem to be basing their confidence on two comforting generalizations.  

One is that the Fed will continue to have their backs, will not allow the market to decline to any degree, that’s the so-called yell and put. The other is the general observation that we are in the third year of the four year presidential cycle and the third year is supposedly always positive.  

Regarding the yell and put, and whether the Fed will continue to have the market’s back much longer, a glance back at history is not encouraging.  Market valuations have reached levels seen at most previous market peaks; that’s by just about every valuation measurement, including P/E ratios, market capitalization to GDP, investor participation, margin debt, and so on.  

History shows that Alan Greenspan was thought to have the market’s back back in the late 1990s.  That was a so-called Greenspan put, but once the market became overvalued, the severe 2000/2002 bear market and the 2001 recession took place anyway.  Ben Bernanke supposedly had the market’s back in 2006 and 2007, the so-called Bernanke put, but once markets became overvalued, the housing bubble burst and the even worse 2007/2009 bear market and recession took place anyway.  

Yet, we now have investors believing the same easy money policies that resulted in those severe bear markets once the market became overvalued now constitute the similar yell and put that assures us that all will be well in spite of the current overvaluations.  I believe that may be misplaced trust for 2015.  

Steven Halpern:  So, as you alluded to earlier in your conversation here, you saw and noted that many market observers are basing part of their bullish outlook on where we are within the presidential cycle.  Before we look at where we are in the cycle more in depth, could you first briefly explain to our listeners, who may not be familiar with this, what the presidential cycle is.  

Sy Harding:  Well, the four year presidential cycle refers to the economy and stock market tending to experience most of its serious corrections and bear markets in the first two years of the four year presidential cycle, while the third and fourth years are almost always positive.  

The driving force behind the pattern is the desire for the incumbent president to be reelected.  History clearly shows that presidential administrations—regardless of party—allow or sometimes even create economic and market problems in the first or second year of their terms to get those problems out of the way.  

That leaves them time in the third or fourth year of their term to do whatever it takes in the way of government spending and other efforts to make sure the economy and stock market are recovered and strong by the time the next election rolls around.  

Steven Halpern:  So you suggested a misconception to believe that the third year of the presidential cycle assures a bull market.  Could you explain how this differs from what most people are feeling right now?

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Sy Harding:  Well, I believe strongly in the historical pattern of the four year presidential cycle, and in fact, it has a significant influence on my investment strategies.  The problem is that the cycle’s history only holds true when a presidential administration is serving its first term and can be reelected.  It is not at all consistent when a reelected administration is serving its second term and cannot be reelected.  

For example, while the normal pattern took place in the first terms of the last three reelected presidents, that was Reagan, Clinton, and Bush, Jr., it did not show up in their second terms when they could not be reelected again.  

There was no serious market correction in the first two years of their second terms, raising the risk that problems would take place later in the third or fourth year, and sure enough, the market topped out in August of the third year of President Reagan’s second term culminating in the 1987 crash in October, at the end of which, the Dow was down 36%.  

The severe 2000/2002 bear market began in 2000, which was the fourth year of President Clinton’s second term, and the 2007/2009 bear market began in 2007 the third year of President Bush, Jr.’s second term.  

We’re now in President Obama’s second term and there was no market correction.  Not even a normal 10% pullback in the first two years of his second term.  

That ties closely to the patterns of the second terms of Reagan, Clinton, and Bush, Jr. when there was no correction in the first two years but serious problems in the third or fourth years of their second terms.  

Steven Halpern:  Now finally, you also closely follow the market’s general seasonal patterns, and based on that approach, we’ll soon be nearing a seasonally unfavorable period.  Could you explain that to our listeners?

Sy Harding: Well the market also has as very consistent annual seasonal pattern of making most of its gains each year in the winter months of October to May, and if there is to be a serious correction, it usually takes place in the unfavorable seasons between May and the following October.  

That annual pattern usually holds true no matter where we are in the four year presidential cycle, so I am expecting that the market is probably going to be alright this year until April or May.  I am very concerned about it thereafter.  

With the market now overvalued, it may be a perilous approach to 2015 to trust that the Fed and the yell and put will continue to have the market’s back or to depend on the popular perception that the third year of the presidential cycle is always a positive year. Those are both misconceptions, regarding the facts.  

Steven Halpern:  Really interesting information.  Thank you so much for taking the time to join us.  

Sy Harding:  Glad to do it.  Glad to be with you.  

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