By Christopher Diodato
As of the date of this writing, the U.S. stock market has been in a bull market for the last 45 months. When comparing the time length of this market uptrend to other bull markets in the past 75 years, it is easily recognizable that the bull market is in its later stages, where we would expect a market peak to occur in the coming months.
Of course, this picture is slightly outdated, since the bull market since 2009 has lasted well over 1.8 years at this point.
These average lengths of bull markets brings the topic of business cycles into this discussion. It has long been accepted that, since WWII, the U.S. economy usually experiences both an expansion and recession every four years. This economic cycle, due to its four-year nature, which coincides with presidential terms, is commonly named the "presidential cycle."
I wanted to quantify the effects of this four-year cycle to see when markets were strongest, and when they were weakest. To do so, I detrended historical prices for the S & P 500 index since 1950 with moving averages and then calculated the distance above/below a centered four-year moving average for each month in the data series. Then, using the month of each presidential inauguration as "month 1," I calculated the average positive/negative stock market bias for each of the 48 months during a president's term.
To clarify, refer to the graph below, which charts my results.
This chart gives the average cyclical bias for all months during a president's four-year term from 1950-2012. Here's how to read it. The horizontal axis tells us how many months it has been since the last presidential inauguration. So, right now, we are entering the 46th month since Obama's inauguration, which means to find what the market's cyclical bias is for right now, we look close to the right edge of the chart, slightly before the number 48.
To find the current cyclical bias, look at the blue line. If the blue line is above the vertical zero axis, that means, on average, the market has a more positive bias and is predisposed to rise. If below the zero axis, then the market has a negative bias. The further away the line is from the axis, the stronger the bias.
Looking at the above graph, one notices that the bias for the market is turning negative right now, and is expected to stay negative for the next two years. Does that mean the market will fall? Not necessarily. Remember, this study is on detrended data. The market can still rally, but will likely not rise at as fast a rate as a rally between months 24-40.
So, why buy now? Two reasons. First, the above graph is for the S & P 500, not individual sectors. Conducting the study, inflationary sectors tended to still have positive bias through months 46-48 and through months 1-9. As an example, the chart below lists cyclical bias tendencies of the Dow Jones energy stocks (red line), (XOM) and (CVX), versus the S & P 500 (blue line) since 1970.
So if you're a buyer, buy selectively. Technology's cycle chart shows that strong bearish biases are right around the corner. Materials stocks (XLB), gold miners (GDX), and energy producers/refiners (XLE) look to be the strongest sectors in which to invest in. Another method of market analysis, called intermarket analysis, also suggests investing in these sectors during extended bull markets.
Still not convinced? What about the Santa Claus rally that the media so often mentions? Don't take their word for it without seeing the facts. Here's a yearly seasonality chart, which tells us which months are often most bullishly biased for the market.
Yes, it's true, the Santa Claus rally is real, and the first few months of spring also bring better tidings than the summer months. This also confirms the other overused market cliche, "sell in May, go away."
Just to check to see if the data was skewed by the chaotic market from 2000 to 2012, I created another model that only tested the years between 1988-2000.
The result? Leave cookies out for Santa, and maybe take a vacation from investing during the summer! The same exact result was found.
So, if you are feeling morose about this market, don't be. There is still a little bullishness around in this market, especially in inflationary sectors, during the next few months. So put your money back to work, and have a happy, alpha filled holiday!
Disclosure: I am long XLE.