Bullish, but Cautious

09/29/2014 9:00 am EST

Focus: STOCKS

James Stack

President, Stack Financial Management

We have a growing concern that the Fed’s ongoing actions and rhetoric are creating a “moral hazard” not unlike that of the housing bubble in 2002-05 or the tech bubble of the late 1990s, cautions Jim Stack, market historian, money manager, and editor of InvesTech Market Analyst.

With the strong rebound in leading economic indicators, including the ISM Surveys, the Fed missed the opportunity to end QE early or relay any impending shift away from their “guarantee” of low interest rates.

For many professionals on Wall Street, as well as the broad investing public, that also guarantees that the bull market has a long way to run. Yet for us, it only increases our level of nervousness in this aging bull market.

The current bull market has displayed one of the strongest and longest advances in market breadth in over 40 years. And judging by the size of positive breakout in this latest advance, market breadth is suggesting this coming quarter might be even stronger than expected in the 4th quarter of a mid-term election year.

Bellwethers, too, are confirming a breakout to new highs in the blue chip DJIA, S&P 500, and in the Nasdaq Index. So this tool also seems to give the market a green light for the rest of the year.

Meanwhile, this year has not followed the traditional pattern for the second or mid-term election, year of the Presidential Election Cycle.

Historically, the second and third quarters of Year 2 are among the weakest of the 4-year cycle. Conversely, the fourth quarter typically sees a strong rally, which ranks it as the best quarter of the cycle.

Year-to-date, however, the stock market has gained over 8%—much stronger than historical precedent would suggest—leading up to the November election.

A better than anticipated start in a mid-term election year does not mean the market won’t continue to move higher through yearend.

We've looked at the performance of the S&P 500 for the initial three quarter period of each mid-term election year since 1942 and what happens in the fourth quarter.

Historically, the Index has averaged a 2% loss for the first nine months of these years. This year, however, we’ve already seen an 8.2% market gain with only two weeks left in the third quarter.

Looking at the 18 years listed, only four have exceeded the current market performance. In each case, the market continued to add to those early gains in the final quarter of the year.

Overall, the outlook for Q4 in a mid-term election year is strongly positive. The average fourth quarter gain for the years is an impressive 7.8%. Seven of the 18 years saw double digit gains and only two years saw Q4 losses (1978 and 1994).

And, as we’ve seen, better than expected market performance early in the year did not affect the fourth quarter outcome.

While there are no guarantees that this year will end on a high note, the odds definitely favor further gains ahead…provided the technical and fundamental evidence remains in the bullish camp.

Subscribe to InvesTech Market Analyst here…

More from MoneyShow.com:

Six Reasons to Be Optimistic

The Adens: What Next for Stocks and Bonds?

Gold: Uncertainty Creates Opportunity

Related Articles on STOCKS