Stock Market Rallies in Mid-Term Election Years

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

Strictly by the rules of this cycle, it is a 2 year hold. That does not guarantee that is starts right on the dime in the fall. We just know from history that the fall represent s the best buying time window. As we put all of the pieces together in constructing an investment or trade, we want to have all the best pieces. I showed the difference between buying stocks in July and exiting in November vs. buying them in November and exiting in May in the newsletter last month. That just by itself shows the difference timing can make.

I will not hold the stocks for 2 years. Years ending in 7 (2007) are notorious for intra year sharp declines, so I will want to dodge that if I can. I do recall finding one year that was very close to a scratch trade with this cyclical pattern, but I do not have that info in front of me right now.

The one comment about earnings that I would make is as follows. They are not dropping yet, you are assuming they will and you may or may not be right. For trading purposes and research, we can only view historically what they were doing at the time of an entry into a trade. We cannot factor in what we thought they would do in the future. There is no way to project back in time and know what our opinion might have been at a specific point in time, as to what earnings would do in the future.

Right now earnings are not dropping, so history would show for example that a trade entered on 8/15/06 was done during a period of increasing earnings. That chart I sent you (poway) on Lennar showed the uptrend in their earnings over the last 12 months. Even though we all expect that to change, currently their earnings as reported are still good.
As a result research into Lennar stock trading in relation to earnings done today would have to feature increasing last 12 month earnings as a variable.

Hope I did not get too technical with this.

[anxvariety]

Years ending in 7 (2007) are notorious for intra year sharp declines, so I will want to dodge that if I can.

Did you read that on Yahoo! Astrology?

There is no way to project back in time and know what our opinion might have been at a specific point in time, as to what earnings would do in the future.

You haven’t seen Back to the Future?

Chris, do you have a spot on your site that shows you performance for more than a 3 year window and profit % rather than % winning trades?

[powayseller]

Ok, let me ask it this way: are there any times you can think of, where the stock market rallied during or just before, a period of falling earnings. A rally could occur during declining earnings based on perhaps the Fed lowering, oil prices falling, a Mideast conflict easing.

I believe earnings will keep falling into next year, until the imbalances in our economy are worked out. Consumer debt must stabilize, and consumers have to either save or get the ability to take on new debt. Until then, the economy will keep slowing. However, if the Fed cuts interest rates in the fall, and we can have a rally. How that rally could sustain for 2 years is beyond me though.

I am looking to get into stocks next year, when earnings are very low, the builders/retailers/banks are hammered due to bankruptcies and foreclosures, and nobody wants to own stocks. That’s when I would get back in.

Your mid-year election cycle plan has historical precedent, but runs counter to what is in the pipeline for the economy. So it requires the stock market to rally in the face of declining earnings.

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

Anx – I am not sure why you try and antagonize me, I do not believe I have ever done anything to warrant this. These things I mention are commonly known things in the fund management world. The sharp mid year corrections in years ending in 7 historically is there, just look at a stock chart of the DOW back to 1900. It is of the utmost importance to be aware of large scale cycles when you are a market timer like I am. They do not always repeat in exact fashion.

As far as the track record on my site. That just reflects the actual results of the system that is featured in the daily trading service, which was created and put into play in Feb of 2004. I have other systems that I use that are not on the site with longer track records. The % return depends on an individuals money management style.

I risk anywhere from 5 to 20% of my accounts on any one individual trade which can make the return percentages very high in good years. 2004 was a triple digit year, 2005 was in the high 70’s percentage wise, and this year it is at approximately 33% YTD(the system has not done as well this year as the last two so far).

You could also figure returns based on the margin of a bond contract which is $2000, however, that makes the return percentage disproportionally high and hence is misleading. Also, a trader should have his margin in T-bills yielding 5% at all times, which also adds to the return, but is not part of trading results.

As a result of all of this, it is hard to state a specific return percentage. I have entered an international trading contest with this system this year, which will provide an actual return % for a full year utilizing all of the trades from the daily trading service. That is the best way I could show a return for someone to see, in an independently audited fashion. I was in first place at one point, and have currently slipped out of the top 3. They only list the top 3, so I do not know where I stand exactly. I only know that the return is currently at 33%, the guy in third is at 44% currently.

At one point I was up 61% and then the system took a couple of losses. I hope this answers your question.

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

Poway, I would say that this trade is not for you to worry about. I probably should have never mentioned this as it has become a can of worms.

All of those discretionary things you mention are not part of the rules for this trade, so I have no idea what influence they would have. None of those things you mention are part of the setup for this trade. I showed you in the newsletter two months ago that lack of correlation between stock and oil prices. I am not sure how much more definitively it could be proved than what I presented.

There have been many stock rallies during periods of declining earnings historically. I am a rule based trader, if something is not part of the rules for a trade I do not care what it is saying. The rules are based on years and years of research, and finding repititive patterns in the markets. I trust in my research and tune out all the noise.

The 30 yr has already rallied a good amount, enough to support a stock rally. Let’s just forget about this and go back to bickering about RE. The OC numbers for July just came out and our incredibly ugly, the bulls are really going to struggle spinning these numbers. This fall is really going to be interesting in RE.

[powayseller]

Chris, your input and experience have been very valuable. My questions are to improve my understanding of the markets. People ask me questions all the time. Look at the objections I am getting over at the months inventory post. I think it is fair for people to question what I am saying; if my system is really that good, I will be able to answer the questions; if I cannot answer the doubters, maybe my system is not that good after all and needs to be modified.

In my opinion, we are heading into a long period of declining earnings later this year, which will bring on a bear market lasting for at least one year. I prepared for this in March 2006, by going 95% cash.

Then, I hear about a very interesting mid-presidential election year rally, which has never missed since the 1930s. Your theory is not anything that needs defending; it is a well known stock market cycle.

I am trying to reconcile the economic slowdown we are heading into, with a historic precedent for a rally in the late fall. I was hoping you could explain how this could happen, and if it happened before.

It’s my understanding that your trading system uses a variety of proprietary trading inputs, but not economic forecasts. You look at the bond yields, technical trading indicators, COT report, and various other things. Is the COT report a proxy for the economy? I assume the COTs go long when they perceive corporate earnings will rise in the near future.

Since you don’t use economic input, you wouldn’t have tracked earnings per share and probably don’t have the data on whether the stock market rallied while earnings decline. But I wonder if the COT report ever showed they were short, and the market rallied anyway. In your trading system, is there a proxy for the economy or do you trade on technical signals alone?

The question posed by anxvariety, about your historical returns is certainly fair. Some of the considerations you use, like not being in the market in years ending in 7, do sound unusual, so it does make one curious. Often a system works well during a bull market or a bear market, or a time of rising commodities (Zeal), but then the system no longer works when economic conditions change. How well will Zeal do when commodity prices retreat?

Also, I am not sure how my question relates to stock and oil prices. Your detailed review of 4 studies showed that oil prices do not affect the stock market, but I think it’s safe to say that earnings, inflation, and the Federal funds rate definitely affect the stock market. Inflation may stop rising and the Fed may lower interest rates, but I’m certain earnings will fall. So the question was: how can the stock market rally when earnings are declining?

I asked Bill Fleckenstein if he expects a rally this fall, in the mid-year cycle. He said

“I do not pay attention to cycles, but I don’t expect a rally this fall– just the opposite.”

I told him that in 1982 and 1990, both recession years, the stock market rallied after and during the recesson. He said

“1982 and 1990 are different from today”

This is just his opinion, and he could be wrong…

One more thing: Barry Ritholtz wrote today that the stock market ralied because core PPI came in low. But the rally will be short lived. PPI fell because low demand for light trucks forced discounts, so truck prices fell. Everything else in the PPI index rose, and rose by a lot. Some materials costs rose over 4%! In an ironic twist, GMs stock rose because demand for its trucks is down.

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

You mentioned oil in your post, that is why I responded to it. Price changes in oil do not effect stock price swings at all from my research.

If you just read my website sections on discretionary trading you will understand why I do not bother with all of these other arbitrary things. I in no way represent that my way is the only way to go, only that it is what I do.

For those who want to synthesize these massive amounts of data collectively, and come to a decision of when to buy and sell, I will leave this thought. Most managers do not beat the S&P 500 each year, and many of them have very powerful people in research staffs doing exactly the same thing. That is very tough competition, yet beating them does not even assure you of beating the averages.

You have to learn to look at things differently from the herd to get ahead. My way is one way of doing that, and there are others.

Please, let’s just move on. We are comparing completely different approaches to investing, and we will never resolve this.

[powayseller]

The Coming Economic Collapse, by Stephen Leeb, PhD

“When we examined the relationship between oil prices and these zigs and zags [recessions and periods of strong growth between 1973 and 2000], we discovered that economic downturns and bear markets were always preceded by rising oil prices In particular, whenever the price of oil doubled over a 12 month period, stock returns ranged from -27% to +4% over the following 18 months. On the other hand, whenever oil prices declined over a 12 month period, stocks returned anywhere from -1% to +30%.”

According to the book jacket, Stephen Leeb “edits the prestigious newsletter The Complete Investor. Renowned for consistently finishing among the leaders in the annual stock-picking contests of the Wall Street Journal and Forbes, he is the author of 5 previous books and holds a BA in economics, MS in mathematics, and a PhD in psychology.”

In the book, he explains that the media, government, and Wall Street is short sighted in not recognizing the oil shortage, and recommends investments that will outperform as inflation and energy costs rise.

Chris, the studies in your newsletter about a relationship between oil and stock prices are pretty short term. 3 of the studies looked at the effect of a change in oil prices on the stock performance the following day. The one study which looked at 12 – 67 day moving averages, found a mild connection. Investors consider the price of oil to be volatile, and therefore don’t base stock decisions on the movement of daily changes in the oil price. Rising oil prices are a problem for the stock market only when they are persistent, because then they are inflationary. A 1 week rise in oil prices doesn’t mean anything. Now with this logic, the past 2 years, where oil prices have been steadily rising, should be bad for earnings, and thus, stocks. The Fed has been raising rates for 2 years, and stocks have held up pretty well. So the mitigating factor is the global liqudity.

You and I have very different approaches to investing. My approach is based on the economy, yours on technical signals. I think when both approaches line up, there should be a much higher certainty of a win. But if you do not wish to discuss this any further, I will oblige.

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