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Summer Rally - In August?

|Includes: SPDR S&P 500 Trust ETF (SPY)
After a slow summer, we may be starting to see signs of life in the US. This is what the market looked like a few weeks ago:

Today, the markets are showing a more healthy picture:

The market has reversed its downward trend and buyers are starting to come back. While the economy still doesn't look pretty there are two big reasons why investors are coming back to the market:

One of the reasons is the talk of extending Bush's tax cuts which are set to expire at the end of this year. A tax cut (or in this case, not raising taxes) has the same effect as the Fed lowering interest rates. 

Allowing the tax cuts to expire will have a slowing effect on the economy. Federal Reserve Chair Ben Bernanke and members of Congress are lobbying hard to make sure the tax cuts do not expire and negatively affect an already weak economy.

Second (and more important) is history. We are about to enter the third year of the Presidential Cycle. This theory states that on average the first two years of a presidential term result in weak performance of the stock market, while years 3 and 4 are stronger -- with year 3 being the strongest.

This theory is backed by convincing data:

Since 1945, 94 percent of year 3 cycles have been positive. These are numbers that market historians cannot ignore. Expect to see investors start to buy into the market early to try to get ahead of the year 3 wave.

Disclosure: no stocks mentioned