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[TTHQ Staff]

BEING STREET SMART
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Sy Harding


LOOKING AHEAD TO 2007! December 29, 2006.

Another year has ended for the stock market. The market came close to following its historical pattern this year. It made good gains last winter, and then had a typical sell-off beginning in early May, in keeping with the old market adage ‘Sell in May and Go Away’. However, where the tendency is for the year’s low created by that correction to be in September or October, this year the low for the year took place in July. Then from its low for the year, the market did see good gains all the way to year end, as is typical.

The Dow gained 16.7% for the year. The S&P 500 gained 14.1%. After being down 15% in the May to July correction, the Nasdaq recovered enough to be up 10.2% for the year.

The year’s big winner was gold, which gained 23.2%, in a very volatile and whipsawing pattern of rallies and corrections. Bonds and the U.S. dollar were losers, with 30-year U.S. treasury bonds declining 3.8% for the year, while the dollar declined 8.0%.

The market has history on its side for the year ahead. As I’ve noted numerous times over the years, the most consistent market pattern I have ever run across is that since at least 1918, from the low in the second year of every presidential term (which 2006 was), the market has had a significant gain to its high the following year (which next year will be). The Dow has gained an average of 50% from that low in the second year to the high the following year.

The rest of the history of the Four-Year Presidential Cycle is also favorable for next year. The third year of the cycle, as each Administration works to get the economy perked up in advance of the election year, tends to be the most positive of the four years.

Of course nothing can ever be totally easy or guaranteed in investing. And there are a couple of potentially serious caveats within the positive tendencies for next year.

The first is that after following the historical pattern of the Four-Year Presidential Cycle very closely in President Bush’s first term, with the severe 2000-2002 bear market in its first two years, followed by the current bull market, the market has not followed it closely in his second term.

The pattern is for a serious correction to take place in one or both of the first two years of each presidential term. It almost always happens. That sets the market up in an oversold condition that helps it make a big gain in the last two years of each term.

However, the market did not suffer a serious correction in either 2005 or 2006, and has now set a record for the longest period in history without even a ten percent correction. Yes, it has been more consistently in one direction than even the rip-roaring late 1990s bull market, in which at least there was a 13% correction in 1997, a 19% correction in 1998, and a 12% correction in 1999.

So the first caveat is that as the market enters the third year of this presidential cycle, it is in the abnormal condition of being very overbought, and overdue for a correction, rather than the usual situation at this point in the cycle of having just had a serious correction or bear market.

There is not a lot of history of this type of situation to provide guidance. One similar occasion was in President Reagan’s second term, when the market also did not have a correction or bear market in either of the first two years of the term. That had the market similarly overbought and overdue for a correction as 1987 began, which was the third year of Reagan’s second term. And of course the market suffered the infamous 1987 crash that year.

The other similar instance was in President Clinton’s second term, when once again the market did not have a correction or bear market in either of the first two years of the term. In that case, the market proceeded well in 1999, the third year of the term, suffering only a 12% correction in its unfavorable season. But then the severe 2000-2002 bear market began early in the fourth year, the election year.

So looking ahead to next year, we are entering the third year of the presidential cycle, which has a very strong history of being a positive year. But that tendency is not so clear if the first two years of the cycle did not produce a serious correction and oversold condition. And the fact that this market has gone for the longest period in history without at least a 10% correction does not give me a warm and fuzzy feeling.

So my expectation is that 2007 will probably follow the history of the third year of Presidential terms, by being positive for the year, by year-end. But I suspect that on its way to that positive ending it will first undergo a painful overdue correction. The unusual heavy selling by corporate insiders since November seems to be saying they agree.


Sy Harding is president of Asset Management Research Corp., DeLand, FL, publisher of The Street Smart Report Online at www.streetsmartreport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market.