“When everyone is thinking alike, then somebody isn’t thinking.” – George S. Patton
Nearly every economist and Wall Street analyst is expecting a recession along with lower stock prices next year. And as the saying goes, when everybody is thinking alike, the universe has a way of proving the majority wrong. There’s certainly a host of reasons why stocks could continue their downward spiral. However, there are some powerful historical statistics on the side of the bulls that are now coming into play. Let’s review each one in detail.
The Santa Claus Rally
Investors have been hoping for a Santa Claus rally – devised by Yale Hirsch and defined as a gain covering the last five trading days of the year along with the first two of next year. Last Friday officially kicked off the Santa Claus rally period with markets closed earlier this week. Yet recession worries along with an aggressive Fed have dampened the seasonal optimism.
We are currently flat from the close of last Thursday, so there’s still time to produce a positive gain for Santa. The bulls would like to see that happen, as when stocks gain during the Santa Claus rally period, the S&P 500 SPY is higher the following year over 73% of the time dating back to 1950, with an average gain of 10.5%.
While a positive return during this period has been associated with further gains, a negative return has tended to precede weaker returns. In fact, since 1950, when there is a negative return during this period, stocks rose just 5% on average, but were still higher 67% of the time. So, even if Santa should fail to call, stocks still tend to end in the green.
The Presidential Election Cycle Theory
Also devised by Yale Hirsch, the theory suggests that the stock market follows a pattern which correlates with a U.S. president’s four-year term. The election cycle consists of the post-election, midterm, pre-election and election years. 2022 is an example of a midterm year, or the second year in the 4-year presidential cycle.
Hirsch discovered that wars, recessions, and bear markets (sound familiar?) tend to start in the first two years of a president’s term. This year, the market entered the weak spot of the cycle. And with an aggressive Fed, high inflation, and the ongoing Russia-Ukraine war, the weakness in stocks was amplified.
Those who know their market history will find it somewhat unsurprising that the start to this year was rough. The second and third quarters of midterm years are historically quite weak.
Image Source: Zacks Investment Research
The good news is that the weak part of the cycle immediately precedes the most bullish part of the calendar. Today marks the final trading day of Q4, which has seen the S&P return about 6.5% this year – in line with the average since 1950. Even better, Q4 in midterm years is followed by the strongest quarter of all – Q1 of year 3 with a 7.4% average gain.
The Historically Bullish Third Year
And when we factor in that the third year of the presidential cycle has historically witnessed the best performance of all four years, the future looks bright following a market reset that pushed equity prices much lower. Under new presidents, pre-election years have witnessed an average return north of 20% going back to 1950.
Image Source: Zacks Investment Research
Investors would do well to take notice of the positive seasonality currently underway. The market normally improves in the latter half of the term as the president attempts to stimulate the economy, making voters feel more positive in an effort to get reelected or keep the current party in power.
The economic outlook remains gloomy heading into next year. Fears of an impending recession and lower asset prices have put a damper on investor sentiment. But if economic fears are overblown, even slightly better-than-expected outcomes can trigger powerful upside momentum. There is a real possibility that 2023 could play out in such a fashion.
Remember - when the crowd thinks they know an unknowable future, they are usually wrong and the opposite occurs. On this last trading day in 2022, I know most investors are ready to put this year behind them. But stock gains and renewed optimism may be just around the corner.
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