Recently Howard Gold wrote an article titled “2012 Could Be A Good Year For The Markets” which is basically an assumption that 2012 could be a better year in the market because it is a presidential election year. This sounds great but should we jump into the market now?
After all even Howard acknowledges that there are a lot of things that have to continue to go right:
“But next year may turn out to be pretty good for stocks. How can I say that? Because from here on, the market’s historic calendar is in investors’ favour. And if we can stay out of recession in the U.S. and avoid one in the developing world, earnings of U.S.-based companies may hold up well enough to support somewhat higher stock prices. (A recession in Europe is already baked into the cake.)
However, what about the election coming up in just a dozen short months? Will it really bode as well for the markets as Howard suggests?
With “hope” running high that things can continue going into 2012 the question becomes can whether or not the Presidential election cycle can hold its performance precedent. According to Howard:
“Most of all, 2012 is a presidential election year and since 1948 markets have gained in every single election year except for two — 2000 and 2008. In fact, stocks have on average put in their second-best performance in the fourth year of a president’s term. (The third year has been best.)”
Howard’s data set went back to 1948 which picks up all of the post WWII cycles. However, using a data set going back to 1833, as shown in the table, we see a little different set of outcomes. Remember, when doing statistical analysis you need the most comprehensive set of data possible to try and achieve a better forecast.
As you can see the 4th year of the Presidential election cycle is actually the second best performing year of the Presidential election cycle. It has been positive 28 out of 43 cycles or 65% of the time. It also has the second best average return of 5.1%.
While better than coin toss the Presidential election year is hardly a “shoe in” for a banner year. More importantly, it is important to note that some of the biggest single year draw downs have occurred during the 4th year of the Presidential election cycle such at 32% in 1917, 23% in 1929 and 33% in 2008.
One thing to remember about all of this is that while the odds are weighted in favour of a positive 2012 from an election cycle standpoint – there have been NO cycles in history when the majority of the industrialized world was on the brink of a debt crisis all at the same time.
While the election of the next President will have an effect on the markets that are looking for policy stability; it is the world stage that will drive investor sentiment over the coming months and years.
With Europe effectively on the verge of a crisis, the U.S. faced with trying to curb spending and reduce deficits and the rest of the world dependent on the strength of both to support their economies – there are more than variables to skew market returns next year.
But there is another cycle that we need to consider which is colliding with the Presidential election cycle and that is the 10-year or decennial cycle.
Using the same data set going back to 1833 we find some more positive news. While the 1st year of the decade (2011) is on average slightly negative it has been positive 53% of time. The big negative years potentially fall in the 7th year (2018) and the 10th year (2020) of the decade. However, what does the cycle say about 2012?
Like the 4th year of the election cycle the second year of the decade tends to be positive 59% of the time with an average return of 5.1%. The best year of the decade is the 5th (2016) which has been positive 83% of the time with an average return of 21.47%.
With a win/loss record of 10-7 an investor betting heavily on a positive outcome for 2012 may be left short changed given the current political, economic and financial environment. Furthermore, negative years in the 2nd year of the decennial cycle correspond with secular bear markets as we are in now.
I have also overlaid the 1st year of the election cycle (green boxes) and when it corresponds with 5th year of the decennial cycle (blue boxes). With 2013 being the 1st year of the new president it is interesting to note that even though the 3rd year of the decennial cycle has been positive 61% of the time the majority of the down years have occurred when the 1st year of the new president coincides with the cycle.
A Lot Of Ifs
All of this analysis is fine but whether the market is positive or negative in 2012 comes down to a lot of “if’s”.
- If we can avoid a recession in the U.S.
- If we can avoid a recession in Europe.
- If corporate earnings can keep rising higher.
Those are some pretty broad “if’s” that we are working with. The U.S. is dependent on Europe for 20% of its exports, the S&P 500 has 20% of its revenue tied to Europe and Europe is in the throws of a recession already.
As far as corporate earnings go – they peaked in the 2nd quarter of this year after having surged, thanks to a massive degree to the repeal of mark-to-market accounting, by 138% from the recession low. There have only be two other times in history where there has been such a boom in earnings – the 1991-2000 tech cycle boom and the 1970-80 inflation boom.
Just as this one did – both previous earning booms came off of depressed lows. However, the difference is that it took just TWO years accomplish what every other period, where earnings increased exactly 138%, took SEVEN years to complete.
This earnings boom cycle was skewed heavily by accounting rule changes, loan loss provisioning, tax breaks, massive layoffs, extreme cost cutting, suppression of wages and benefits, longer work hours, a plunging dollar, extraordinary government stimulus and solid international growth.
So, if, somehow, maybe, possibly, all these things can be sustained we should be just fine. The problem is, however, all of the pillars that supported the earnings boom are now going away beginning next year, each of them to some degree, which throws into question the sustainability going into 2012. In other words, the reality is far less rosy than the “IF’s.”
My point is that while doing statistical analysis on things like Presidential election cycles, decennial cycles and the “super bowl” certainly make for interesting articles and reports. It is crucially important to remember that what drives the financial markets both in the short term is psychology and sentiment.
In the next 12-18 months there will be more than enough event risk to skew the potential outcomes of the markets. This doesn’t mean that you should go and hide all in cash or gold. It does mean that you need to actively pay attention to your money.
This idea plays into our global macro allocation theme of income, hedged investments and precious metals as an alternative to direct market risk. With expectations of lower economic growth in the coming quarters, reduced earnings and pressure on the consumer the markets are likely to remain highly volatile in the coming months without making much overall progress.
And while we are in the midst of prognostications don’t forget the biggest of all which is that 2012 is the end of the Mayan calendar. So, anything other than that will be a much better outcome.