I’ve been thinking a lot recently about where we are in the stock market cycle and I’m not alone in that. After a significant loss of momentum this year and two aggressive stabs on the downside there are a lot of people asking questions about the market’s condition.
The bond market has been grudgingly nudging yields higher for the last few years as the Fed has persisted in raising rates. At 2.92% right now that is pricing an average of 2 and a bit more interest rate hikes by November 2020. Since the next one is due in a month that’s not a terribly ambitious forecast which suggests fixed income investors do not believe the Fed can continue indefinitely on this current path. It occurred to me over the weekend that something which has not gotten a lot of mention recently is the US Presidential Cycle.
David has often talked about this cycle as something to keep in the back of one’s mind during the second half of the 3rd year of a first-term President’s tenure in office. This post from Comment of the Day on October 26th 2016 may be of interest. Here is a section:
Beyond a brief post-presidential election honeymoon, I used to describe the first two years of a new four-year cycle as equivalent to Hercules cleaning the Augean Stables.
Around 2H of the third year of the presidential election cycle, the Fed would commence stimulating the economy once again. This often provided a decent bull run which was particularly strong from the low point in the third year through yearend of the election year. Of course all things being equal, which they seldom are due to endless variables and permutations, any market cycles beloved by some analysts are likely to be imprecise.
Nevertheless, a look at this 10-year weekly chart of the S&P 500 Index shows a sharp dip in 2015, the pre-election year, followed by a rally during most of 2H 2015. However, 1Q 2016 was certainly a negative surprise in terms of the presidential election cycle, before a respectable election year rally followed. Looking back at the previous cycle, we see a sharp dip in 1H 2011 (the third year) before a good rally in 2H which continued throughout most of 2012 (the election year). There was certainly no cleaning of the Augean Stables in 2013 or 2014 because the Fed was highly stimulative.
Looking back even earlier, we can see that 2007 (the pre-election year) was choppy and 2008 (the election year) a disaster, followed by a strong rebound from 2Q 2009.
There have been news stories over the last week to the effect that the stock market has not had a negative return in the 12-month following the mid-term elections since at least 1950. That’s quite similar to the positive performance of the Presidential cycle in the second half of the 3rd year.
So what has happened over the last two years? On the fiscal side, we have seen the epitome of procyclical policy with massive tax cuts acting as a stimulus. That contributed to a lengthy post-election honeymoon period for the market that lasted all of 2017.
At the same time the Federal Reserve has been raising interest rates steadily since the end of 2016 and is now also reducing the size of its balance sheet. That is a clear example of the Fed cleaning up its act in the first two years of this presidency.
The stock market has been quite weak so far in 2018 and with consumer heading into next year’s tax season without the benefit of being able to write off mortgage interest payments, state and local taxes there is bound to be some uncertainty in high population, high tax, high property price states like California, New York and New Jersey.
That could be a drag on stock market performance through the first half of next year. If the Fed stops raising rates or even cuts rates that could also be a significant catalyst for a recovery in the 2nd half of next year. There are a lot of questions in those two sentences and it is not a prediction but if the Presidential Cycle is still relevant then it is a potential roadmap.