Three Cycles To Watch in 2014

We hear about stock market cycles all the time.

We can look at short-term stuff like the annual seasonal cycle for U.S. stocks. For example, we are currently in the best three-month period of the year: November - January. We are also towards the beginning of the best six-month period of the year: November - May.

We can break it down even further and talk about the Santa Claus rally that typically comes late in December. But today, I want to focus on some of the longer term trends that seem to be coming together in a nice way.

The first one is the Presidential Cycle that represents the standard four-year presidential term. The second one is the Decennial Cycle that tracks stock market behavior for the 10 years of each decade. And the third one is the longer-term Secular Bull and Bear Market cycles.

Presidential Cycle

The Presidential Cycle is one that we take very seriously. We've taken a look at every U.S. presidential term since 1929. We are currently finishing up the "post-election year" and about to enter year two, or the "midterm year". On average, year one tends to be a positive one peaking somewhere in the fall. The midterm year historically isn't one of the best. The theory behind this is that presidents tend to get off to a good start making promises and keeping everyone happy. Then they take care of the dirty work that rubs the public in the wrong way. And then the final two years tend to be extremely positive as presidents prepare for their own reelection, or to help their own political party.

The reasoning behind this is less important than the actual performance statistics, but fun to think about either way, even for me. Currently, we are in the early stages of the worst 13-month period of the entire four-year (48-month) Presidential Cycle. The reason I think this is important because both the pre-election year (2015 in this case) and the election year (2016) tend to be the best periods of the Presidential Cycle. We took it a step further and differentiated between Republicans and Democrats and found very little difference in the results. I thought that was interesting.

So this particular pattern is telling us to take advantage of any major correction next year. Remember the end of the worst 13-month period of this cycle is next September.

Decennial cycle

The decennial cycle, or decennial pattern as it is sometimes referred to, is an important one for us. It takes into account the stock market performance in years ending in 1,2,3 etc. In other words, we are currently finishing up 2013, which is the third year of this decade. We would include this year with 2003, 1993, 1983, 1973 and so on. Next year represents the fourth year of the current decade and has a decent track record. The average return for the Dow Jones Industrial Average since 1894 for the fourth year of the decade is 9.23%, but positive just 66% of the time. That's not very conclusive.

The piece of the puzzle that I consider to be more reliable here is the fact that next year sets us up for what is considered to be the most bullish year of them all: year 5. The statistics for the fifth year of the decade are staggering. Since 1895, the average return for year 5 is a humble 28.9%. But what really stands out is the hit rate. Every fifth year has been a positive one for the Dow Jones Industrial Average 11 out of 12 decades. And that one down year was 2005, where the Dow lost just 0.61%. The decennial pattern is certainly suggesting that we take advantage of any major correction in 2014 to do some buying.

Secular trends

The third cycle that I think is worth discussing as we enter the new year is the pattern of Secular bull and bear markets; "secular" meaning 10+ years, rather than shorter-term cyclical bull and bear markets that take place within each bigger secular trend. A consistent topic of conversation among technicians is whether or not we are already in the next secular bull market. I've never seen such a smart group of market participants so split on one particular topic. I think we can all agree that the secular bull market of the ‘80s and ‘90s peaked in 2000, where we then entered a secular bear market. Notice how within this last secular bear, we did have a cyclical bull market between 2003 and 2007 sandwiched between crashes.

With that in mind, the average secular bear market going back over 100 years lasts about 17 years. If we are still in this "secular bear market", we would be entering year 15 this upcoming April. I understand that we have already exceeded the 2000 highs in most of the major U.S. stock market averages (nominal, not inflation-adjusted). But I think it's important to keep in mind that in 1980, the S&P500 was finally able to break out above its secular bear market highs of the 1960s and 70s. That "breakout" turned out the unsustainable and fell 28% to the final cyclical low in August of 1982. So historically speaking, although I am still in the camp that 2009 marked our secular bear lows, it would not be unusual to have one more cyclical decline before we can confirm that we are in the next secular bull market.

Taking all three of these cycles into account heading into the new year, I think we can agree that all of them suggest buying the next cyclical decline aggressively to prepare for the next long-term secular bull market.

Source:

Three Cycles To Watch in 2014 (MarketWatch)

Tags: $SPY $DJIA