economic/stock market cycle: 4 years or 8?

phone call from sunny CA

My younger son called the other day to talk about the stock market.  He reminded me that I had often spoken as he was growing up about the four-year stock market cycle seen in the US.  It’s sometimes called the presidential election cycle, from the belief that the sitting president injects PEDs into the economy in the fourth year of his term to aid his reelection bid.  It’s also called the inventory cycle.

the traditional four-year market cycle

The idea behind this is that in the post-WW II US the typical period of business cycle expansion, during which government policy is to stimulate growth, has lasted about 2 1/2 years.  As we reach full employment and upward wage pressure commences, the policy stance reverses.  Interest rates rise; the economy slows–and sometimes contracts.  This latter period lasts around 1 1/2 years.

The stock market exhibits the same behavior–2 1/2 years of up followed by 1 1/2 years of down–but leads the economy by about six months.

a rule of thumb

The four-year cyclical pattern generates a practical rule for investors:

–when the stock market has been rising for two years, start thinking about becoming more defensive, and

–when the market has been falling for a year, think about becoming more aggressive.

the eight-year cycle

The point of my son’s phone call is that this traditional pattern can’t be found in charts of market action for almost two decades.  It has been replaced instead by an eight year cycle–5 1/2 years of up, followed by 2 1/2 years of down.  More importantly, two months ago, we entered the fifth year of rising market.

His conclusion from looking at the charts:  early in 2014 the S&P will hit the skids.

 

This is a very interesting thought, even if it turns out not to be correct.  It makes you stop looking the leaves on individual trees and start to think about the shape of the forest as a whole.

differences?

Is the stock market situation today substantially different from the tail end of the internet bubble of 1999, or of the emergence of the mortgage fiasco/financial crisis of 2008?  If so, what are those differences?   …can we conclude that today’s story will end up any better than those two did?

I think there are key differences.

More about this on Monday.

 

 

the four-year “Presidential election” cycle in the US

As a stock market rookie in the late 1970s, I started to absorb what was hen conventional wisdom.  Looking over charts of the movements of the S&P 500 over prior decades, investors had reached the conclusion that the US stock market traced out an irregular four-year pattern.  For roughly 2 1/2 years, stocks generally went up; for the following 1 1/2 or so, the went down.

There was some macroeconomic sense behind this movement.  The mandate of the central bank, the Fed, has been, and continues to be, to maintain maximum sustainable, non-inflationary growth in the domestic economy.  If the economy started to grow too fast–meaning wage inflation was starting to occur–the Fed would raise short-term interest rates to cool the economy down.  In those pre- supply chain software days, the policy change might take six months to have any noticeable effect on corporate or consumer activity.  The economy might take another year or so to slow to the point that Fed felt justified in lowering rates to keep the economy from deteriorating further.

Wall Street linked this economic rhythm with a political one–the desire of the incumbent president to create favorable economic conditions during election year–so that either he could be reelected to a second term, or at least his party’s candidate would have a tactical electoral advantage.  How would the president do so?  He would pressure the Fed to take an inappropriately stimulative stance about a year before the election so that the domestic economy would be powering along just as voters would be going to the polls.  After the election, the inappropriate stimulus was to be removed through contractionary action by the Fed.

Stock market lore revealed that every modern president did this, with the sole exception of Gerald Ford, who paid a penalty for his economic honesty by not being elected.  …which, pundits argued, made every subsequent president that much more eager to try monetary policy manipulation.

Quaint, to our 21st century eyes, but true.

Nevertheless, that’s the genesis of the idea that the first year of the new presidential term is a testing one for stocks and bonds.  Interest rates are presumed to be rising as cleanup from the late-term party of the previous election cycle begins.

Even though we’re in a globalized world today, where the US is not the only industrialized power and where economic developments in Asia, Europe or Latin American can have important consequences for the domestic economy, many Wall Streeters haven’t advanced much beyond the clichés of over a half-century ago.

The present situation in the US differs markedly from the Presidential cycle in two main respects:

–the Fed has publicly announced that it won’t be changing its current ultra-stimulative stance for at least the next 2 1/2  years

–the major impediment to growth is fiscal, the inability of Washington to reach a compromise on how to begin to pay back the large amount of debt the federal government took on during the Great Recession.

If press accounts are to be believed, a large part of the Washington gridlock comes from President Obama’s unwillingness to enter into pragmatic and meaningful discussions with Republican legislators.  He’s promised to change his ways if reelected.   Let’s hope he carries through.