Breadth Thrusts & Bread Crusts: A Look at the "Why?" Behind a Popular "What?"

JC Parets
August 25, 2022

From the desk of Willie Delwiche.

During our “Trendlines over Headlines” conversation last week, Patrick Dunuwila and I spent some time discussing seasonal patterns in the stock market. Among the inputs to our cycle composite is the 4-year Presidential Election cycle. The tendency for stocks to make a pre-midterm election low and then see sustained strength in the year between midterms and the Presidential election is well-advertised. The stats around this are pretty amazing. On average, stocks bottomed two months prior to the midterm election and, despite a few close calls, the S&P 500 has been higher one year after every mid-term election since 1950, on average nearly 15% higher.

This is often ascribed to the market’s preference for certainty. When the balance of political power is unknown, stocks weaken. When the outcome of the election becomes more obvious, stocks rally. This is regardless of which party that outcome favors. It’s a plausible story as far as it goes. 

There are other factors playing on seasonal patterns as well, and the headlines this week are a great reminder of that. On Wednesday afternoon, President Biden announced the details of a plan to forgive student loan debts. It’s beyond the purview of this discussion to weigh in on all the details or even the merits (or lack thereof) of the plan. 

But two points are worth making before getting back to seasonal patterns in the stock market. First, forgiving student loans doesn’t actually wipe out the debt, it shifts the responsibility for the liability (in this case from the individual to the federal government). Second, offsetting the inflation effects of this plan would require an additional 50 to 75 basis points of tightening by the Fed. In other words, Biden is giving back what Powell & company just took away at the last FOMC meeting.

The broader point is that this type of fiscal stimulus is entirely consistent with what we have seen in the past, from both parties. As can be seen in the chart from Ned Davis Research, behind the 4-year presidential election cycle in stocks is the tendency for monetary & fiscal policy to become more accommodative in advance of mid-term elections and to continue to be expansive heading into the general election two years later.

Liquidity is the lifeblood of financial markets. 

Stimulus is the lifeblood of political careers. 

When there are elections on the horizon, the two can become almost indistinguishable. 

We’ve seen it in the past and we are seeing it play out again in the present. Often knowing the “what” is enough for us to take some action, but sometimes knowing the “why” can be really interesting. Even if the motivations seem less than ideal.

You can catch the entire “Trendlines over Headlines” show here. The discussion about seasonal patterns begins at the 11 minute mark.

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