What Does History Tell Us About The Coming Cycle?

1.) CYCLES – There are various cycles that exist in market space. Some are worthwhile because they’ve been very consistent over the decades, and others…well…not so much. One that has been pretty consistent though is the “Presidential Cycle”.

Most investors have probably heard of the four-year presidential cycle.

Instead of treating every year the same, we can separate the market into the post-election year, midterm year, pre-election year and election year, then look at how the S&P 500 has historically behaved through each part of the cycle.

We’re currently approaching the end of September in a midterm year.

If the pre-election year has historically been the strongest part of the presidential cycle, when has that strength typically started?

Testing all 7-month periods gives the answer.

The strongest historical seven-month window begins at the September month-end of the midterm year and runs through the April month-end of the pre-election year. Historically, the average S&P 500 return is +18.3%, ranking first among all 48 possible seven-month starting points in the presidential cycle. And we’re about to enter that phase on Thursday.

Testing the data further revealed that this is more than just average “seasonality”. After all, Oct – Apr are historically pretty good months. When October through April fell specifically between the midterm and pre-election years, the historical numbers changed considerably. This is where the average return jumped to 18.3%, while 94.7% of those periods finished higher.

Of course, “averages” can hide a lot. A handful of enormous gains can make a historical tendency look much stronger than the typical experience.

Look at every individual occurrence (2nd chart).

There have been 19 completed periods in the study. The only “bad” period began in 1978, when the S&P 500 declined -0.8% between the September month-end and the following April month-end.

Some gains were very large, and times when most would probably not have thought those gains were possible…1974 stands out. That was during the oil embargo…stress for the oil market. Back then, the inflation adjusted price of a barrel of oil would have been about $83.

Of course, these “averages” don’t tell the story of what investors had to sit through. As always, the path wasn’t smooth. The breadth deterioration that I’ve written about is likely part of that non-smooth path we could be headed into.

History says we’re about to enter a period that’s been unusually favorable for the S&P 500. But seasonality doesn’t make weak breadth disappear. And an average historical path doesn’t tell us what the S&P 500 has to do this time. It just gives us context.

So what I’m looking for now is if more stocks start reclaiming their 50-day moving average, and if more sectors join them. Moreover, does leadership begin expanding again?

2.) OIL – Oil is in a bullish condition on both an immediate (3 weeks) and intermediate (3 months) basis. What’s that telling me? Oil likely is headed higher, unless of course there is some real resolution to the whole Iran mess. Something else that could be a tailwind for oil are the stock piles. So far, the world has kept itself supplied with fuel through the disruption by drawing on the oil it had already stored. Right now, the scale of that drawdown has no parallel in the available record. At some point, those stockpiles need to be rebuilt. That means buying oil…an increase in demand. Will they be able to keep price from accelerating while rebuilding the stockpiles? Good luck with that.

3.) DEFENSIVES – Some time back I wrote about “hiding places” within the market. Sectors that tend to get bid up when investors are demanding safety versus growth. Back then, it was obvious that no one was taking shelter. So far, that has not changed. Consumer staples and utilities are two of the most defensive areas of the stock market. When investors get scared, they often hide in these groups. Nobody's hiding there right now as those two sectors have gotten blasted. Some of that also has to do with rates, as Utilities are very rate sensitive.