Bernanke Vs. The 4-Year Presidential Cycle

by: Sy Harding

I recently wrote a piece pointing out the history of the four-year presidential cycle and how it's a potential bad omen for the stock market this year or next (or both). The pattern of the cycle is that there is usually, but not always, a market correction in the first two years of each presidential term, and then recovery and a strong economy and market again in the last two years of the term leading up to the next election.

Not unexpectedly, given the high level of bullish investor sentiment, I received a number of emails from investors pointing out why the cycle would not be a problem this time around -- because the market cannot go down as long as Fed Chairman Bernanke is determined that it will not. And stories of the history of the presidential cycle are interesting but are looking back not ahead, and so are of little value. But history is useful in two ways. The first, as noted by my correspondents, is in providing stories of past times such as the Civil War, the old South, prohibition -- interesting for their entertainment and educational value.

Then there are historical statistics, as utilized in virtually all research to discover important patterns and relationships that result in new knowledge, methods, and strategies for the future. For instance, constant research into previous years of auto and aircraft accident statistics results in continuous safety improvements. Research into years of statistics regarding smoking resulted in changes that save many lives. Subjecting new drugs and surgical procedures to trials over a period of years and then analyzing the statistics, makes it possible to predict the odds or dependability of achieving the same results in the future, advancing survival rates. That is the use to which history is put when we compile the statistics of the four-year presidential cycle not as an "interesting story," but as a means of perhaps increasing the survival rate for investors.

And that history shows that over the last 110 years there have been 25 bear markets, or one on average every 4.4 years. They were tied quite closely to the four-year presidential cycle and its strong pattern of corrections in the first two years of each presidential term. In the last 18 presidential cycles, a correction has taken place in the first two years 16 times, or 89% of the time. The average decline was 24.6%. Additionally, history shows that of the 16 times corrections took place in the first two years of the cycle, 12 times they began in the first year and only four times did they begin in the second year.

Since we are apparently in a contest between the presidential cycle and the Fed, let's also look at the Fed's history. An interesting comparison to today is something I wrote in an article I titled "The Fed, The Economy, And Engineered Soft Landings" in December 1999:

Since his gaff in 1987 [raising interest rates, which many credited with causing the 1987 crash], Alan Greenspan has proven to be a magician with the economy and stock market, certainly doing a masterful job in the efforts to extend the longest economic revival in history. Perhaps he can continue the levitation. Investors and the sales side of Wall Street now praise Greenspan as the best Fed Chairman ever, giving him credit for keeping this wonderful economy and powerful stock market on track so long, forgetting his past gaffs.

And here we are in 2013, with Greenspan discredited for not preventing the 2000-02 recession and bear market by continuing easy money policies for too long, and Fed Chairman Bernanke being credited with being the best Fed Chairman ever, a magician in keeping this bull market running for so long with his easy money policies. Forgotten is how, appointed in February 2006, like Greenspan he was way too late in realizing what was going on and the impact of his policies. Bernanke continued to raise interest rates to slow what he thought was an overheated economy until September 2007, even though the real estate and subprime mortgage bubbles had burst in 2006. He insisted those events would not impact the economy, which would continue to grow, so higher interest rates were appropriate.

And when he turned out to be wrong and the 2007-09 bear market began in October 2007, with the fed funds rate at 5.25%, he only slowly and reluctantly began cutting rates 0.25% at a time to restimulate the economy. He didn't become more aggressive until 2008 when the financial meltdown had become obvious, and by then it was too late. If it is a contest between the odds of a correction presented by the four-year presidential cycle, and the "Bernanke put," it looks as if investors and Wall Street have made the same choice they made with Alan Greenspan in 1999. Bernanke has been a magician in keeping this bull market going, and will continue with the magic. In fact, when it becomes time to remove the stimulus, he will be able to engineer a soft landing that will not impact the economy or market.

Of course, engineering a soft landing by central banks is always the hope in every cycle, not only in the U.S., but globally. How often does that work out? Given the history (there I go again) of 25 bear markets over the last 110 years, or one on average of every 4.4 years -- not too often.

So we shall see.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.