Presidential Cycle Adds to the Risk
Market Views of Comstock Partners, Inc.
Thursday, August 18, 2005
For some time now we have felt that the upward move in the market that started in October 2002 was a cyclical bull market within a longer-term secular bear market. That this is indeed the case is supported by the fact that the S&P 500, at its recent peak, was still 20% under its all-time high made in March 2000. In secular bull markets stocks have never been below a top made five years earlier. We have also believed for some time that the cyclical bull market was running out of steam and ready to resume its downtrend. The market now is about at the same point it was at the end of 2004, and it is increasingly likely that the entire period since that time is part of a distribution top.
Supporting our view is the historical tendency of the stock market to perform poorly in the first two years of a presidential term and come on strongly in the final two. This tendency is even more pronounced in secular bear markets. The last secular bear market from 1966 to 1982 included the first two years of four presidential terms. On average the S&P 500 dropped 33% from the peak of the first presidential year to the bottom of the second with a range of 20% to 50%. In keeping with this historical record, the index declined 44% from the high in 2001 to the low in 2002. These numbers are most likely not a statistical coincidence, but an indication that most administrations would rather get the bad news out of the way early in a presidential term, and then pursue economic policies that get the economy and markets moving strongly again before the next election.
There are also a lot of other good reasons why the historical pattern of the presidential cycle might be valid this time as well. We have long stressed the structural imbalances left over from the late 1990s bubble including the record trade deficit, the near-zero consumer savings rate, record household debt, the federal budget deficit, and the unbalanced reliance of the economy on the booming housing sector. We are now also faced with a number of more immediate factors that have almost always led to sharply lower economic growth or outright recession. These include the steadily tightening monetary policy, the narrowing yield curve, the slow growth of money supply and soaring oil prices. When we also take into account the continuing high valuations and investor complacency, it seems to us that the upside is limited while the risk of a severe downturn is extremely high.
© 2005 Comstock Partners, Inc.
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