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How to Use Cyclical Analysis to Trade the Right Market Sector (Part 1)
06/09/2008 12:00 am EST
Since this article was written in June of 2008, which is a Presidential election year and the fact that as a trader I am always looking at ways to study and get clues for making trading decision for short, intermediate, and longer term trends or cycles. This article will go over why it is relevant to understand the effects of elections on the economy and the stock market. If you are to trade and invest this year then these concepts might help you in the months leading into the election and should be applicable for you in the years and decades ahead.
There are many theories on why the fabled four year cycle works, one is, and it certainly is a very logical explanation, is that it is tied to a politically based business cycle model. Economist have found and have developed a business model to determine what the business cycle might be based from political decisions. Political business cycle theory states: When an administration is elected, it initially adopts a contractionary policy to reduce inflation and gain a reputation for economic competence. It then adopts an expansionary policy that leads up to the next election, thereby hoping to stimulate the economy and lower the unemployment levels as the election day approaches. This year might be significantly different as compared to prior election years due to the health of the mortgage and the US financial institutions, but the fact remains we have an increase in inflationary pressures and under the current Presidential administration, a stimulus package was passed giving tax rebates to American voters.
Before we delve into the where we are in the current business cycle let me review what we have discovered based on historical information dating back since 1942. Bear markets have historically occurred during the first or second years of presidential terms. A bear market is defined when the S&P 500 index's decline is approximately fifteen percent or more over a period of one up to three years, while a bull market is an environment of consistently rising prices. Keep in mind that the magnitude of price moves, or percentage changes have had various degrees through the decades because of multiple forces such as unforeseen macro events in the past and now and in the future as we are undergoing the expansion of a globalized economy. As a result, some cycles have been shorter in duration and some are longer than the norm. For example, 1946 to 1949 was a shorter cycle, while 1982 to 1987 and then the boom cycles of 1994 to 2000 were longer than average cycles.
More in Part 2 tomorrow.
By John Person
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