Down Pre-Election Year Is Precursor To A Down Election Year

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Includes: DIA, QQQ, SH, SPY, VTI
by: Tom Au, CFA

Summary

Last year was a glaring exception to the rule that the U.S. market "always" goes up in the year before a presidential election.

The last two similar exceptions for pre-election years were in 1931 and 1939, and were followed by down years in 1932 and 1940.

Independently of the above, the two election years in the 2000s most similar to 2016 have also been down.

Other global macro factors argue for a down year in 2016.

Disappointing profits for American companies are the last nail in the coffin.

2016 USA The U.S. stock market "always" goes up in the year before a presidential election. Except that 2015 was a glaring exception to this rule. What's worrisome is the fact that the two previous exceptions were in 1931 and 1939. The earlier year signaled the depths of the Great Depression. The later year marked the start of World War II (in Europe). The associated election years, 1932 and 1940, were down years as well.

More to the point, two of the four election years beginning in 2000 were severely down years. The two "good" election years were 2004 and 2012, that featured a first-term president, who was running for re-election, and favored to win. The second type of election year is that of 2000, or 2008, where there is a lame-duck president, and a credible threat of a change of party control.

In 2016, the front-runner for one of the two major parties is one Donald Trump, who is not an established politician. That's surprising because the kind of American non-pol that gets nominated on a major party ticket, and then elected, is usually a war hero like George Washington, Dwight Eisenhower, or any number of Union generals, beginning with Ulysses S. Grant, after the Civil War. Even so, Trump's candidacy strikes us as being plausible. If he is elected, it would probably be because the electorate sees him as a "General of Finance," and believes that the country is at, or headed, to a financial "war." That's not necessarily good news for the market.

The candidate in the race that represents the greatest continuity is Hillary Clinton. Unlike most others, she does have a track record from one or more previous Democratic administrations, and is a relatively known quantity. This is a pragmatic observation, not a partisan one - my preference is for Donald Trump over either Hillary Clinton or Bernie Sanders - but the fact is that a non-Clinton candidate would take more time to 1) install an administration and 2) to make it a credible factor in the governing of America.

There are now reports that (former) New York Mayor ("America's Mayor") Michael Bloomberg is mulling a run for the presidency as an independent. If he does, this would be a relatively credible Ross Perot/Teddy Roosevelt third party type candidacy. The election of a "third party" presidency would put the U.S. market into uncharted waters. More likely, Bloomberg would roil the market by adding uncertainty to the two party race, perhaps by throwing the election into the U.S. House of Representatives (as George Wallace might have done in the 1968 race).

This election year lacks some tailwinds that other such years usually enjoy. Normally, the Fed would begin a period of easing, especially since Fed chairmen enjoy greater job security if the next president is from the same party as the one who appointed them. But after years of "quantitative easing," the Fed has squandered this bullet. In fact, the Fed recently began a "tightening" cycle, something that it "never" does going into an election, out of deference to the incumbent party and the maintaining of the status quo. Given the strength of the U.S. dollar, this is likely to force other developed countries to raise rates also, even when their economies are slowing.

Beginning in the late 20th century (when it started to matter), there were a number of crises in developing countries that conveniently took place in off-years of the U.S. election cycle. In 1986, oil prices collapsed, hurting the economies of oil producers; in 1994, Mexico devalued its currency, sending its economy into a tailspin because of its own election cycle; and in 1998, a number of developing countries all suffered severely at the same time from global liquidity issues. But in each case, the issues were resolved before the U.S. elections. Now, on the other hand, China appears to be falling into a period of "slow growth" (6% is just that for China), and more to the point, pulling down the prices of commodities and the economies of other developing countries that produce them. This appears to be having negative "feedback" effects on the U.S. economy.

Profits of American companies are falling, and in any event, are disappointing U.S. investors. That suggests that America and Americans are suffering, rather than benefiting from, the malaise that is affecting other parts of the world. Coming at a time when interest rates are rebounding, this argument "closes the loop" for a bear market case. I am out of the market in what I believe will be one of the five or so worst years of the 21st century (the comparably bad years of the 20th century were 1929, 1930, 1931, 1932, 1973 and 1974).

Themes: Election cycle

Disclosure: I/we 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.