A Reliable Indicator Points To Big Correction In 2014
You’ve probably heard of the January Effect and the Super Bowl indicator. These are popular indicators that many market forecasters use to make broad predictions about stock market moves for a given year.
But there’s another indicator that you may be less familiar with…
The Presidential Cycle indicator.
This market forecasting tool was recently discussed in an article by Covestor with the assistance of long-time market historians, Sam Stovall and Sy Harding. And if the indicator holds true this year, it could have major implications for your portfolio.
The Presidential Cycle indicator focuses on the market’s historical performance during each year of the president’s term since World War II. Now this may not sound like a very scientific approach to market forecasting, but I promise you the data reveals an interesting and timely trend.
The trend I’m referring to relates to the market’s penchant for corrections during the second year of a president’s term. According to data provided by S&P Capital IQ, the mid-term election year has experienced the greatest number of notable market declines since 1945.
Sam Stovall, the Chief Equity Strategist at S&P Capital IQ, described the trend this way to Covestor…
“Since WWII, mid-term election years have seen pullbacks, corrections, and bear markets conclude within these years, and these declines averaged 20%.”
Stovall went on to explain…
“Much of this ‘mid-term mayhem’ is due to its placement within the presidential cycle.”
A chart provided by S&P Capital IQ to Covestor showed the sum of all market declines greater than 5% since WWII broken down by each year within the four-year presidential cycle. Here’s a summary of the data depicted by the chart…
- Post-Election Year…………………………. 20%
- Mid-Term Election Year…………………… 37%
- Pre-Election Year………………………….. 25%
- Election Year……………………………….. 18%
As you can see, 37% of all notable market declines since 1945 have occurred during the mid-term election year. This is highly relevant as we’re in the second year of President Obama’s second term. If this historical trend holds true, then we’re in store for a significant correction this year.
And that’s not all…
The Covestor article also referred to disturbing analysis provided by Sy Harding’s Street Smart Report related to the mid-term election year. Harding noted that corrections during the second year tend to be more severe when there was no correction in the first year “and when the market, investor sentiment, and valuations had become quite extreme.”
As you probably know, it’s been more than two years since we’ve seen a correction of 10% or more in the S&P 500. And you could make the argument that the market, investor sentiment, and valuations have become “quite extreme”.
But all is not lost…
Harding also pointed out that “since at least 1918, there has been a significant rally from the low in the second year of the cycle to the high of the following year, a rally in which the Dow gained an average of 50%.”
So, what conclusions can we as investors draw from this data?
If the market follows these historical trends, we’re likely to see a severe market correction at some point this year. However, once the correction runs its course, the market should begin a major rally that carries into next year.
Of course, history never repeats itself exactly as events played out in the past. But according to the Presidential Cycle indicator, the odds favor this sort of broad market action over the next 22 months.
Profitably Yours,
Robert Morris
Category: Stocks
