The Four-Year Cycle: The Four-Year Cycle — Let’s Check the Numbers

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Jan 31st, 2006 | By | Category: Investing Strategies, Macroeconomics

Mark Bail discusses The Four Year-Cycle again, this time going into the numbers.

Hello again, Sleuths,

In my prior two columns this month, I’ve made the argument that 2006 will be a tough year for equities. One of my reasons for having a bearish outlook was because of where we are in the four-year, or presidential, cycle. In my most recent column, I explained what the four-year cycle was and why I believe there is merit in its recurring patterns.

Last time, I laid out the theory behind the four-year cycle. In this column, I’ll give you some numbers to demonstrate those recurring patterns and what the cycle suggests is in store for us in 2006. Then you can reach your own conclusions and formulate your game plan for the year accordingly.

Before I throw some numbers at you, I know what you may be thinking. You’ve been reading the paper or going online and wondering, “What is this guy Bail talking about? How could he be such a bear when the market is ripping?”

The Four-Year Cycle: 2006 Is the Year of Bearishness in the Cycle

As I watched the market close out last week so strongly, I asked myself those very questions — except I didn’t refer to myself as “Bail.” But then I reminded myself that this forecast encompasses an entire year. And despite the market’s positive start to 2006, we’re just putting the finishing touches on the first month. So we’ll see what the remaining 11 months have in store for us.

I have one other thought to share with you. Two days after I penned my last Sleuth issue, I was watching CNBC. Right in the middle of that morning’s festivities, a money manager appeared on the tube and declared that 2006 was going to be a tough year for stocks. What was his reason for being so bearish? He said the four-year cycle pointed to 2006 being a bummer for most stock investors.

Now, I don’t remember who that guy was. But he went on to state in no uncertain terms that the four-year cycle led him to conclude that we should be in for a rough time this year. Well, that certainly caught my ear. I even wondered if he was a Sleuther.

No matter. He was articulating a lot of the same points I’ve been making. I generally don’t like to have a parade of financial folks appear on CNBC espousing the same views as my own. Quite frankly, I take comfort in being different from the crowd. And it’s not because I’m a loner or a contrarian. It’s just that I’ve noticed that consensus opinion is usually wrong.

But then I took comfort in the thought that most people probably didn’t agree with that money manager. I figured — with the market off to such a nice start this year — most folks probably let the man’s words drift in one ear and out the other. Besides, most people probably hadn’t heard of the guy. I know I hadn’t. So I just sat back and chuckled.

Now, let’s take a look at those numbers and you will see for yourself the power of this pattern. In my Jan. 17 Technical Tuesday column, I compared the first two years of a four-year, or presidential, cycle with the second two years. I wrote that the third and fourth years of the cycle have typically outdistanced years one and two, and why that happened. And since we’re smack in the middle of years one and two, let’s check the numbers and see what history tells us about what we might expect at this point in the four-year cycle.

The numbers I’ll share with you are from the S&P 500 and quite interesting. However, I also looked at the annual historical returns of the Dow Jones Industrial Average and the Nasdaq. The implications from the historical results of all three indexes with respect to the study of cycles are similar.

OK, so what can the S&P 500’s history tell us? First, I looked at the previous 11 presidential terms — going back to 1961. In other words, I analyzed every presidential cycle beginning with the start of the Kennedy administration. I then combined each term into two two-year periods in order to evaluate the combined total return for the S&P 500 during the first and the second years of every four-year period against the results achieved in the third and fourth years of the cycle. 

The Four-Year Cycle: The Second Two Years of a Term Explain It All

Here’s what I found. In nine out of the 11 presidential terms from 1961-2004, the combined total return for the second two years exceeded the return for the first two years. The only exceptions were in 1985-86 and 1997-98.

Now I know that (like the current situation) — those two exceptions occurred in the second terms of presidents -– Ronald Reagan and Bill Clinton, respectively. However, three points need to be made that I think differentiate those times from this one.

First, in both of those prior instances, the economy was booming. That’s certainly not the case now. And both the 1985-86 and 1997-98 periods were supported by an accommodative Federal Reserve. Given the Federal Reserve’s string of 13 consecutive increases in the federal funds rate — with possibly one more scheduled today — that certainly hasn’t been the case this time.

Here’s one more difference — and it’s a big one. In both of those two-year periods, the first year returned outsized gains. In 1985, the S&P 500 went up 26.3%, and in 1997, it jumped 31%.

Contrast that with the year just completed. Unlike those eye-popping gains of 1985 and 1997, in 2005, the S&P 500 was able to inch ahead a rather modest 3%.

What about the other nine presidential terms? I’m glad you asked. In every single one of those nine four-year cycles, at least one of those first two years — either year one or year two — finished with a negative return. Now, 2005 was a positive year, albeit modestly. Therefore, if this pattern continues to hold, odds point to the S&P 500 finishing 2006 in the red.

You want more? To really put this historical pattern to the test, I went back further — all the way back to 1929, the beginning of the Hoover administration. And I looked at the eight four-year cycles covering the period from 1929-1960.

Now, prior to the 1960s, the S&P 500 sometimes scored greater gains in the first two years of a presidential cycle. For example, the index posted higher returns in the first two years of the four-year cycles of the immediate postwar period — the second Truman term (1949-1953) and both Eisenhower terms (1953-1957 and 1957-1961).

But as with the results from 1961-2004, I was interested to learn exactly how many times the S&P 500 suffered through at least one down year in the first two years of the four-year cycle. Well, guess what I found? Seven of the eight four-year cycles encompassing the presidential terms of Hoover through Eisenhower contained at least one down year in either year one or two. Only in Truman’s second term did the S&P 500 finish with positive returns in each of the first two years, 1949 and 1950.

 

Now think about what I’ve just said. In the last 19 presidential cycles — a period stretching from 1929-2004 — the S&P 500 ended at least one of the first two years of the four-year cycle with a loss on 16 occasions. That’s a rate of 84%. Those are pretty good odds. So with the S&P 500 having ended 2005 in the black, odds greatly favor 2006 being a negative year.

The famous Spanish philosopher George Santayana said, “Those who cannot learn from the past are doomed to repeat it.” I hope that this look into the last three-quarters of a century of market history gives you a longer-term context from which to view current equity trading patterns. As always, it’s smart to watch current stock trends and react accordingly — rather than try to force your will upon the market. Still, it’s always good to know from whence we came — and thus, where we may be headed.

Trade well,

Mark Bail
January 31, 2006

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