Stock Market Rallies in Mid-Term Election Years 2

[lewman]

The previous post of the same subject by powayseller seemed to have waned but I’d like to continue the discussion.

I asked myself the question “if I had bought the index at the lowest point in a mid-election year and hold until the next interim peak, what’s the probability that I would make money and how much would I make”.

The table below shows the S&P 500 (year is the mid-election year, month is the month during which the lowest point occurred i.e. best time to buy, and duration is number of months the index rose from the lowest point until its next peak, and change is the percentage change from the lowest point to the next peak):

Yr Month Duration Change
1962 jun 35 73%
1966 oct 9 33%
1970 may 11 51%
1974 oct 9 53%
1978 mar 6 22%
1982 aug 11 67%
1986 sep 14 47%
1990 oct 40 42%
1994 apr 34 46%
1998 aug 11 48%
2002 jul still going

I generally defined a peak to be a correction of around 10%, and my computation is not accurate to the last digit but I believe I’ve convinced myself that in the past 40 years, the probability to make money seems to be 100% provided I bought at or near the lowest point of the mid-election year.

Will 2006 be a repeat or will this pattern be broken because of a slow down/recession/stagnation around the corner ? My next step was to see what a recession right after a mid-election year would do but it’s getting late. I do think that there will be a slow down or even a recession coming up barring any unforeseen circumstances like war but probability to win is so high that perhaps as Chris suggested one should forget trying to predict what would happen and follow the pattern, and if it does turn out to be an exception, this trade would just have to go into the loss bin that hopefully has fewer trades than the win bin 🙂

The next question is: is the correction since May over ? If history is a guide again, it seems to suggest it is not yet over. From 1962, S&P500 would have dropped an average of 24% from the previous interim peak to the mid-election year low point and it would have taken an average of 10 months to do that. But the spread is large: in 1986 it dropped 9% in 1 month but in 1974 it took 21 months to drop 48% before reaching the lowest point in the mid election year.

Any comments ? And any suggestion of what an entry strategy could be for this trade to increase the chances to win ?

[powayseller]

Very interesting, and thanks for sharing your results. The strategy calls for buying in the fall of the mid-year cycle, and I noticed a number of your years are buying in the spring. So what are the results if you buy in October every year?

Bill Fleck and a trader on his site both told me that 1982 and 1990, both recession years, were different than today. Stocks rose in those mid-election years because inflation and interest rates were declining, and the recession was either behind us or close to it.

Why are you considering this short-term rally as a “still going” category? This rally is just a Fed-is-done rally. Historically the stock market falls into the fall, and I anticipate this year is the same.

I studied these last decades also, and this is the first time that we are entering into a recession in the mid-year cycle. There is no way this rule can work entering into a recession. I am guessing the commercials will not go long, and so this trade won’t be executed.

The danger of following patterns is they are backward looking. Perhaps the pattern is, “Stock markets rally in mid-year presidential election years as long as we are not facing rising inflation or an economic slowdown”. People looking backward, not aware of the full rule, don’t realize the markets rallied in those years only because there was not an economic slowdown.

For this reason, technical and fundamental analysis have to work hand in hand. The COT report shows what the insiders are doing, and rest assured, they follow the fundamentals. So using the COT report can be a proxy for studying the economy. Let them do it for you, right? This is my understanding of the insiders, but perhaps Chris can correct me if this is not accurate. Going into a recession, perhaps the COT will show insiders playing some rallies, but not going long.

Once we are in a recession, and stocks are hammered, that’s when I want to get back in the market. The economy will turn around during the recession, and the economists won’t report it until several quarters later. Again, I am interested in whether the COT report shows the insiders getting in early.

Chris, what is the rate of return earned in the stock market if someone followed only the COT report, and did exactly what they do? How much better are they are predicting the market?

[LAcrash]

I’ve followed the prior thread with interest and am now following this one. Last September I purchased a large amount of somewhat conservative mutual funds with the money I got from selling my home the year before; they’re now up about 7%. The one-year surrender-charge period ends in about a month, just a few days before the next Fed meeting, and I’m deciding whether to cash them out and put the money into a money-market fund, or leave the money in the funds until I’m ready to use it as a down payment on a house. Suggestions?

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

PW – The COT report is a tool to help us gain an advantage to beat the market as a whole. If you straight up test buying with Commercials long vs them being short, there is an increased accuracy, avg per trade, and total dollars made. However, it is not a stand alone rule, just one thing I use to help time my entries.

They are heavily long now as of last Friday’s report which surprised me. I tested the results of buying the SP 500 in August when the commercials were over 90% long on a relative basis, and exiting in October. The results were horrible, and a trade that should definitely not be done. In fact, I then studied the individual situations when this confluence occured, and some big selloffs occurred from exactly this situation.

We do have downside bias starting on the 15th trading day of the month of August which is here. My other indicators that track things are diverging on this rally, so I am expecting it to fail any day. For the record, just to be straight, I have missed this upmove off the lows except in my short term SP 500 trading system, where I made some money but not alot.

We do have this very strong cyclical up bias for this year as I have been talking about. Large institutions are well aware of this bias, and might be front running it here. Time will tell. Also, we have had a nice rally in 30 yr bonds, which is more than likely the main reason for this big move up. Dropping long term rates are very bullish for stock prices.

[lewman]

powayseller: good point about the recession and it is one of my concerns; was going to look at impact of a recession / rate increase & decrease but it was getting quite late and my brain wasn’t functioning anymore; having said that, while i share your opinion there will probably be a slowdown or even recession but fact is I don’t know that … using my personal life as an example: when I got married several years ago, the wedding would happen during the typhoon season; my wife wanted an outdoor wedding and I vetoed it … I figured if past pattern tells me the likelihood of rain on the wedding day is high then I got to trust it and if it later turned out to be bright and sunny … oh well … I know I will never hear the end of it for as long as I live but at least I won’t be the subject of a funniest home video

re: investing in october vs spring … I didn’t select spring, the months noted were the ones when the lowest point was registered on the S&P500 during a mid-election year in the past 40 years; I also looked at Nasdaq since 1974 and interestingly out of the 9 mid-election years since then October was the best time to buy during 5 of those years while July, August, and September each took one year.

[lewman]

Further studied this and looked at rate increase / recession impact.

First question I asked: if I assume a recession is around the corner, should I still expect a market recovery starting from a mid-election year. Unfortunately during the past 40 years, there has never been a recession which began after the mid-election year rally started. So I can’t refute the theory that this pattern could repeat despite a recession (or otherwise). There had been a number of instances where a recession had already started before entering the mid-election year but I don’t think it counts as the market could have been anticipating the end of the recession thus started to bid up stock prices. To me this question remains unanswered. Having said that I don’t know if a recession is coming in the horizon anyway.

Second question I asked was whether the rate hikes since ’04 could have stopped this pattern from repeating. Since 1962, there were four instances where rates were increased before the mid-election year. They were 1966, 70, 74, and 78 and a nice recovery followed each of these mid-election years (+33% in 9 months from the low point in 66, +51% in 11 months from 70, +53% in 9 months from 74 and +22% in 6 months from 78).

But each of these were also preceded by a sizable market drop which I believe set up the subsequent rebound. In 1966, it took 9 months and a 22% correction to reach the low point in 1966, 17 months and 36% drop for 1970, 21 months and 48% drop for 1974, and 14 months and 20% drop for 1978.

We still have a few months before winter. If this pattern were to repeat, it perhaps means there ought to be a rather sizable correction over the next month or two.

I also want to look at market PEs but don’t know where to get historical PEs for the market. Anyone got a link for me ?

[powayseller]

leung_lewis, I truly appreciate your generosity in sharing your results with us. This took a long time to figure out. Very interesting stuff.

What is most noteworthy is this:

1) we’ve never gone into a recession during the mid-year cycle, so the pattern may not hold this year

2) every rally came from a low, and was preceeded a by a long bear market. This is clearly not the case.

To me, it looks like this year is different. Our economy is different now. We are truly at a breaking point. We traded in our productivity, and investment in education and research and development to foreign financed consumption and debt creation.

There are many other factors which could have made these past rallies work: falling interest rates, strong dollar, low inflation. Maybe you need all these to line up to get the mid-year rally.

[sdrealtor]

I have to chuckly when hearing “It’s different this time!” not matter what it applies to.

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

Do not over think this one folks.

[sdrealtor]

CJ,
I’m not! I sold out everything that I had in my 401K mutual funds on Friday. I’ll be watching to see when it’s time to buy back in.
Thanx
SDR

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

SD – good move, I think you will be pleased in a couple of months. The point I am making is the same one that I put in prior posts. When researching things, the worst thing an individual can do, is formulate an opinion, and then try and make the data fit it.

The data needs to formulate the opinion. This mistake is what is called over-optimizing. It is backwards logic to look at a strong cyclical tendency that has rarely failed and try and find the reasons why it will this time due to a pre-disposed opinion of what you think will happen.

As I said in my prior example, lumber has rallied starting on the 18th trading day of October for 18 straight years. Should I try and figure out why this year will be the one that fails? Or should I buy it on that day and play the odds?

I already know what I am going to do.

There are large picture fundamental reasons why this pattern has repeated over and over. That is all that I need because I am a systematic trader. I do not trade on my opinions, I would be broke if I did.

It is difficult to find a comfort zone if you over analyze things too much. There is always something else to look at that could be “the missing piece.” You just have to line up the probabilities on your side and take the trade.

[lewman]

My crystal ball tells me things are getting really bad … recession or even stagflation later this year or next year and in fact like you sdrealtor I also sold my mutual fund holdings in june and just maintain a long position on oil-related stocks as a bet on energy prices staying high … but problem is my crystal ball had been wrong many times before so I’m trying learn how to make money by not having to rely on my crystal ball … ha ha ha

btw, chris, looks like you’ve reconciled with beijing as for the first time in months I can access your website & blog !

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

Leung – thanks for the update. I suspected it must be available everywhere by now based on some of the emails I have gotten recently. Just find out what I did wrong to get in their bad graces, so I do not repeat the mistake!

[powayseller]

Love your sense of humor, sdrealtor. That was a good one…

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