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[TTHQ Staff]

BEING STREET SMART
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Sy Harding


BULLS & BEARS CONTINUE TO DEBATE. APRIL 8, 2005.
It’s been a long time since the stock market moved in any recognizable trend.

For all of last year, the Dow rose only 3%, the S&P 500 9%, and the Nasdaq 8%. But even then, until November, the market had been down for the year, and so made those gains for the year only in November and December. A two month move doesn’t qualify as much more than a short-term blip, especially given that since December the market even gave back those gains.

In the first three months of this year, the Dow and S&P 500 each lost 2.6%, and the Nasdaq lost 8.1%. The result is that trendwise the market has gone nowhere in either direction over the last 15 months. So the bulls and bears have been debating for a long time without a winner being declared. Will the market’s next real move be to the upside or the downside?

That the market continues to trade in such a flat and indecisive manner indicates that neither side is convincing investors to any degree. So far.

I expect that the moderator of the debate, being the market itself, will soon declare a winner. And I suspect that the market’s seasonality will have a lot to do with it. The market has a long history of making most of its gains each year in its ‘favorable season’ between November and April, and suffering most of its declines in the unfavorable season of May to October. The pattern has been so well-known among Wall Street insiders that it resulted in the long-time Wall Street maxim of “Sell in May and Go Away”. Studies by respected market historian Yale Hirsch showed an investor could just about match the performance of the S&P 500 over the long-term, while being exposed to market risk only 50% of the time, by simply entering the market on November 1, and exiting to cash on May 1.

My own research built on Yale’s work by adding a technical charting indicator, which either triggers a sell signal before the calendar date, allowing an earlier exit, or remains on a buy signal when the calendar date arrives and thus keeps an investor in past the calendar date when the market is liable to continue rising. That simple change created a seasonal strategy that has almost tripled the performance of S&P 500 over the last seven years, with similar results when computer back-tested over the previous 50 years.

According to its rules that strategy became bullish and has been 100% invested since last October 16. But that same seasonal approach is now saying the market could be close to its next unfavorable seasonal period, in which it suffers most of its declines.

And this time the unfavorable season will take place within a longer-term negative pattern, which involves the Four-Year Presidential Cycle. For many years, upon winning a Presidential election, each administration has tended to allow whatever corrections are needed in the economy and stock market to take place in the first two years of its new term, and then pulls out all the stops in the form of economic stimulus, in the second and third years, to make sure the economy and stock market are recovered in time for the next election.

The good news is that since 1918, from the market low thus created in the second year of each Administration, the stock market has produced big rallies to its high in the following year, rallies in which even the conservative Dow averaged a gain of 50%.

The bad news is that this is the first year of the next Four-Year Presidential Cycle, which makes the odds very high that the market will see a significant and important low in the 2nd year of the cycle, which will be next year.

Put those two conditions together, the unfavorable May to October seasonality, taking place in the first year of the Four-Year Presidential Cycle, and the bulls need a lot going for them to overcome the history. But do they have a lot going for them?

Unlike during the 1990s bull market, inflation is now rising, some say at an alarming rate. And interest rates are now rising, with seven rate hikes by the Fed since last June, and the Fed’s promise of more to come. The stock market does not like either rising inflation or rising interest rates, because they take spending money out of consumers’ hands, and consumer spending accounts for 65% of the nation’s Gross Domestic Product.

Meanwhile, in the background are the macro concerns of record consumer debt, record U.S. budget, trade, and current account deficits, even a potential housing bubble.

Bulls can argue all they want that the economy continues to hold up (so far), or that the housing sector has shown no signs of slowing (yet). But the stock market looks ahead to what it expects conditions to be six months to a year ahead, and I don’t see anything in current economic or political conditions that will allow the market to disregard its own consistent seasonality, the Four-Year Presidential Cycle, and the time-tested criteria that indicate serious economic imbalances that need to be corrected.



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.