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[TTHQ Staff]

BEING STREET SMART ____________________ Sy Harding The Inaugural Address Provided a Clue for Markets! January 21, 2005. We are now in the first year of the next ‘Four-Year Presidential Cycle’. President Bush’s inaugural address this week provided strong clues that the cycle’s long history of influence over the economy and stock market will continue. To refresh your memory, the first two years of each Presidential term tend to be poor years for the stock market, while the last two years, and particularly the third year, tend to be very positive for the market. The driving force behind the pattern is just as clear as the pattern itself. In the second and third year of every Administration great efforts are undertaken to make sure the economy and stock market are in good shape by the time the next election rolls around. The downside of that is that those efforts usually create imbalances and excesses that need to be corrected. And once the election is history, each Administration tends to do nothing to prevent whatever corrections are needed to at least partially correct the imbalances. So the economy and stock market tend to have problems in the first two years of the cycle, until sometime in the 2nd year when Washington pulls out all the stops again to make sure the economy and stock market are in good shape again by the next election. And so it goes, cycle after cycle. The pattern is so consistent that the rally that has taken place from the low in the second year of every Administration (since at least 1914), to the high in the third year, has produced an average gain of 50% in the Dow. President Bush’s first term followed the pattern precisely. The first two years saw the recession of 2001, and one of the most severe bear markets of the last 100 years. As with most Administrations, not much was said about the economy in those first two years, except that America is strong and its economy would bounce back. And by September of the first year the 911 terrorist attack took place, providing another reason to ignore the economy. Then in perfect harmony with the cycle, Washington moved the economy to the front burner in the 2nd and 3rd year of the cycle, with a giant stimulus plan that included increased government spending, tax rebates, tax cuts, and lower interest rates. And sure enough, the bear market ended in October, 2002. From that low to the high at the end of the following year, the Dow gained 47%, just about equal to the 50% historical average of such moves. Now we have entered the first year of the next Four-Year Presidential Cycle, and there seems to be every reason to expect the long history of the cycle will continue. The imbalances are certainly in place, with record budget, trade, and current account deficits, over-valued stocks, record consumer debt, a potential real estate bubble, etc. The next question is whether the Administration will continue to follow the cycle’s pattern of pushing the economy onto the back burner again now that the election is over. There was a pretty strong clue in President Bush’s inaugural address. For the last two years of his first term, in spite of a war in Iraq and numerous terrorist threats, much of the effort and promises from Washington revolved around the economy, the jobs situation, tax cuts and other efforts to get the economy going again. However, President Bush’s inaugural speech this week, launching the new term and its goals, did not contain even one reference to the economy, consumers, jobs, investments, or matters related to them. It was entirely about the Administration’s responsibilities to “defend our freedom”, “encourage reform in other governments”, “seek and support the growth of democratic movements in every nation and culture”, etc. Further evidence that Washington’s focus is now off of the economy again can be seen in the changed attitude toward the Federal budget deficit. The talk of the last two years was that the growing budget deficit was inevitable because of the cost of the war, and was okay because it was also financing a pick-up in economic growth. Now the Administration is promising to cut the annual budget deficit in half. Meanwhile, the Federal Reserve, which was lowering interest rates so aggressively over the last two years to stimulate the economy, now seems to think it went too far, and has been raising rates again, supposedly to get them up at least to a neutral level. Neither the economy nor the stock market likes rising interest rates. That’s more than enough evidence that the long record of the Four-Year Presidential Cycle remains intact. If so, the next low-risk buying opportunity will be from the market’s low in 2006 (the 2nd year of the cycle), for a substantial move to its high the following year. That does not mean the bull market that has been underway since the market low in 2002 is necessarily over just yet. But it does mean that until that low in 2006 is seen, investors are well advised to be cautious with upside expectations, and willing to go after gains from the downside when appropriate, and to pay attention to other areas, (like gold?). 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.