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Summary

  • Geopolitical risk roils the markets on a daily/weekly basis lately, adding to investor nervousness.
  • Year 2 of the Presidential cycle curse now adds to the uncertainty, raising the possibility for more volatility and short term weakness for this bull market.
  • Despite the "noise" and the "cycle", when the dust settles at the end of the day, history shows, the bull market resumes.

I recently penned commentary noting how there are opportunities created and presented to the patient investor due to market weakness over geopolitical issues.

Headlines regarding the Russia/Ukraine situation, Iraq and other issues have preyed on the nerves of investors lately. Nervous traders and investors have their eyes and ears fixated on every headline crossing their path. As a testament to that, one only has to go back to the last 2 weeks of action in the S&P 500.

The S&P racked up losses early in the week of August 11, due to concerns over geopolitical fears, dropping from 1938 to an intraday low of 1904. A headline that Russian troops had pulled back from the Ukraine border brought the buyers back in at the end of that week, wiping out the entire weekly loss.

Fast forward to this past week where the S&P continued with its rally only to stub it's toe on Friday, August 18th. The average saw a quick 20 point reversal during the day, all due to a headline that Ukraine had attacked a Russian convoy.

Now, amidst the geopolitical concerns, it seems there is yet another obstacle the bulls will have to endure, the "two year curse". Appropriately, it refers to "year 2 of the presidential cycle".

The beginning of the year is often full of talk about what indicators to watch as to how the year may unfold as many decide to give their annual predictions. Many are followed like religion, the "first five days indicator", "the January effect", both made famous by Yale Hirsch and his Stock Market Almanac. Others like the Super Bowl indicator, even the Chinese lunar New Year cycle, claim to tell us either the outcome for the year or the pattern stocks may take for at least part of it.

While most of these are little more than folklore (Super Bowl results and Chinese new Year) they are easily discredited once you dig into them. However, there is one that has stood the test of time, and it is, the Year-Two Curse.

Year two of the presidential cycle has typically been a volatile one for investors. The start of the second quarter to the end of the third quarter of "year two" has consistently marked the biggest peak-to-trough decline of any year of the four-year presidential term. It is for that reason that I believe it is appropriate to dig into this market phenomenon a bit more. Another reason for my desire to bring this to the attention of investors, it is already being highlighted by some to make a "case' for a market correction, with overtones that the bull market may in fact be over.

In my view, it will in fact, present yet more "noise" to the already nervous investment scene. And I'll demonstrate later, that while it may be rolled out to prey on the "fear " of the average investor, this cycle is nothing to "fear" at all.

(click to enlarge)

Source: The Leuthold Group

Let's take a look as to what is typically reported as to the "Why" of this event. The pattern may be so enduring, not because of the events in Washington during the mid-term election year, but perhaps because what happens with the DC crowd. Their actions/inactions, affects our mood and how we perceive other events, making us prone to be more pessimistic and sell when events inevitably occur. Perhaps (the one that the majority subscribes to ) this "mood" comes from buyer's remorse after a year under a newly elected or re-elected President or the fear-mongering rhetoric that often comes from the mid-term election campaigns.

Whatever the cause, or what one may, or may not believe, it seems clear that the events that acted as catalysts for the more substantial declines in the S&P 500 Index during the year-two curse of the past 25 years had little to do with the election or events in Washington:

  • a 20% drop in the market in 1990, was due to a recession that developed as oil prices spiked in the summer prompted by Iraq's invasion of Kuwait.
  • a 19% fall n 1998, fall was sparked by the effects of the Asian financial crisis and related failure of the hedge fund Long-Term Capital Management.
  • In 2002, the 33% plunge was tied to the lingering aftermath of the bursting of the tech bubble and the rash of corporate scandals that followed Enron, including big names like WorldCom, Tyco (NYSE:TYC) and Adelphia. ƒ
  • Again in 2010, the 16.0% decline followed the end of the Federal Reserve's first bond-buying program, QE1 (quantitative easing), on March 31, 2010 and economic growth faltered.

These events were real market movers for sure, and as shown were coincidental to the "curse" years.

So what is really going on that keeps this pattern so enduring. The following facts should make an investor sit up and take notice. Nine of the 13 presidential terms since 1960 have seen losses during the "cursed" second and third quarters of year two. That 70% likelihood of losses during the period of the year-two curse is double the 35% frequency the market has been down over any two quarters since 1960. Another sobering thought for the bulls, every mid-term year drop since 1998 has taken SPX negative for the year and under its 200 day MA.

Now the 64,000 question, will the year-two curse repeat in 2014? There are some "excuses" or reasons that may precipitate it occurring again. Perhaps a temporary economic soft spot develops in the third quarter. After all, weak economic data readings led to 5% or more pullbacks beginning in the spring of each of the past four years. We may again see some weakness here in the seasonally weak period of August.

Of course we surely can't dismiss all of the geopolitical noise that is around us as another reason for market weakness in the days/ weeks ahead and many will seize on that and cite the "curse". One thing we can be sure of, the "naysayers" will be launching their efforts to make their case to "fear" the curse, and warn that the bull market is about to end.

Stepping back to reality shows that the curse may be a blessing for some, allowing those who have been awaiting a long-overdue pullback a chance to buy.

While no one knows for sure that this "cycle", or if you will, the "curse' will in fact play out, here's what I do know.

After the year 2 presidential-cycle correction, (if it occurs) the S&P on average has experienced a 40% return over the subsequent 10 quarters. That dovetails nicely with my call that we are indeed in a secular bull market and in my view, stock prices will indeed be higher than they are today.

Keep this data point in mind, when the "naysayers" and media are filling our ears with the "Bull market is over" cries. As they will invariably cite everything from the "curse' to all of the geopolitical "noise" to create more "fear".

This will in fact be a wonderful opportunity to take advantage of that "fear", by adding names of quality stocks to your portfolio. Companies showing increased earnings quarter after quarter with solid fundamentals that may be unduly punished in a nervous investment scene. This secular bull market is far from over, "curse" or no "curse".

Best of Luck to all!

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. I am long numerous equity positions - all of which can be seen here on my SA Instablog.

Source: Geopolitical Risks And Now The 'Presidential Cycle Curse' - Will They Lead To More Short Term Market Weakness ?