Historic Victory! Now What?

By: David Chapman | Sun, Nov 9, 2008
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Congratulations to President-elect Barack Obama on his historic win on November 4. He does represent a watershed in American politics. But once the applause dies down, as inevitably it will, the real hard slog begins. He has inherited a mess.

So just what kind of mess?

Obama was greeted by the worst post Election Day collapse ever, as the Dow Jones Industrials fell five per cent. This surpassed the 4.5 per cent decline that greeted Franklin Roosevelt in 1932 and the 3.9 per cent drop that greeted Harry Truman in 1948. The next day the DJI fell another 4.9 per cent. Welcome Obama.

Despite such a nasty drop, the odds of a market in endless liquidation over the next four years are extremely low unless one believes we are headed into a 1930s style Great Depression. Records show that only the hapless Herbert Hoover ever experienced a stock market that never had an up year during his presidency.

We thought we would show you the Presidential election stock market cycle from 1885. The record shows that often due to wars, recessions and bear markets, the markets are weakest in the first two years of the cycle. As prosperity returns the presidential cycle improves, with the third year recording the best gains. We divided our tables into Republican and Democrat Presidents.

4-Year Cycle
Beginning
Republican
presidents
Post-Election
Year
Mid-Term
Year
Pre-Election
Year
Election
Year
1889 B. Harrison 5.5 -14.1 17.6 -6.6
1897 W. McKinley 21.3 22.5 9.2 7.0
1901 W. McKinley * -8.7 -0.4 -23.6 41.7
1905 T. Roosevelt 38.2 -1.9 -37.7 46.6
1909 R. Taft 15.0 -17.9 0.4 7.6
1921 W. Harding ** 12.7 21.7 -3.3 26.2
1925 C. Coolidge 30.0 0.3 28.8 48.2
1929 H. Hoover -17.2 -33.8 -52.7 -23.1
1953 D. Eisenhower -3.8 44.0 20.8 2.3
1957 D. Eisenhower -12.8 34.0 16.4 -9.3
1969 R. Nixon -15.2 4.8 6.1 14.6
1973 R. Nixon*** -16.6 -27.6 38.3 17.9
1981 R. Reagan -9.2 19.6 20.3 -3.7
1985 R. Reagan 27.7 22.6 2.3 11.8
1989 G. H.W. Bush 27.0 -4.3 20.3 4.2
2001 G. W. Bush -7.1 -16.8 25.3 3.1
2005 G. W. Bush -0.6 16.3 6.4 -27.4 ****
Total % Gain 86.2% 69.0% 94.9% 161.1%
Average % Gain 5.1% 4.1% 5.6% 9.5%
# Up 8 9 13 12
# Down 9 8 4 5

* Assassinated
** Died in office
*** Resigned
**** Year to date

Republicans: average gain - 6.1%
# up - 42
# down - 26
% up - 61.8%

Perfect records: W. McKinley 1897-1900
C. Coolidge 1925-28
R. Reagan 1985-88

Nothing but losses: H. Hoover 1929-32

4-Year Cycle
Beginning
Democrat
presidents
Post-Election
Year
Mid-Term
Year
Pre-Election
Year
Election
Year
1885 G. Cleveland 20.1 12.4 -8.4 4.8
1893 G. Cleveland -24.6 -0.6 2.3 -1.7
1913 W. Wilson -10.3 -5.4 81.7 -4.2
1917 W. Wilson -21.7 10.5 30.5 -32.9
1933 F. Roosevelt 66.7 4.1 38.5 24.8
1937 F. Roosevelt -32.8 28.1 -2.9 -12.7
1941 F. Roosevelt -15.4 7.6 13.8 12.1
1945 F. Roosevelt* 26.6 -8.1 2.2 -2.1
1949 H. Truman 12.9 17.6 14.4 8.4
1961 J. Kennedy** 18.7 -10.8 17.0 14.6
1965 L. Johnson 10.9 -18.9 15.2 4.3
1977 J. Carter -17.3 -3.1 4.2 14.9
1993 W. Clinton 13.7 2.1 33.5 26.0
1997 W. Clinton 22.6 16.1 25.2 -6.2
  Total % Gain 70.4% 51.6% 267.2% 50.1%
Average % Gain 5.0% 3.7% 19.1% 3.6%
# Up 8 8 12 7
# Down 6 6 2 6

* Died in office
** Assassinated

Democrats: average gain - 7.9%
# up - 35
# down - 20
% up - 63.6%

Perfect Records: F. Roosevelt 1933-36
H. Truman 1949-52
B. Clinton 1993-96

Source: Stock Trader's Almanac 2008

When it comes right down to it, neither the Republicans nor the Democrats hold much in the way of bragging rights over the other. The Democrats have a slim lead with regard to the percentage of "Up" years, and Democrat years tend to be somewhat better for the markets than Republican years (average gain 7.9 per cent versus 6.1 per cent). In the third year of a presidency the Democrats have a big lead, with an average gain of 19.1 per cent versus 5.6 per cent for Republicans. Republicans have an edge of 9.5 per cent to 3.6 per cent for gains in the fourth year of a presidency. There is little to choose between them for the first two years.

Both parties have had three presidents with perfect records of four consecutive years of up markets, with Republicans William McKinley, Calvin Coolidge and Ronald Reagan joining Democrats Franklin Roosevelt, Harry Truman and Bill Clinton. Only the aforementioned Herbert Hoover (a Republican) has the ignominyof four consecutive years of losses. The biggest one-year gain is 81.7 per cent - in 1915, for Woodrow Wilson in the third year of his presidency, while once again Hoover saw a 52.7 per cent decline for the largest decline, also in the third year (1931) of his presidency.

We don't believe that this stock market will have the kind of collapse that buried Hoover. There were a lot of conditions present in 1930 that do not exist today to cause that collapse. We believe that this collapse is more in keeping with the financial panics of 1906-07 (101 years), 1937-38 (70 years) and even 1973-74 (34 years). There are some interesting similarities.

Financial panic declines (DJI):

1906-07 - 48.5 per cent
1937-38 - 49.1 per cent
1973-74 - 45.1 per cent
2007-08 - 43.3 per cent (to date).

We are not suggesting here that we have seen our final low. Typically, after the kind of collapse we have seen thus far, we get a rebound before we plunge to our final lows. In 1907 we had our absolute low in November; then followed a feeble rally that eventually had a higher low in January 1908. Similarly we had our low in March 1938 and after a feeble two-month rally we made another higher low in May 1938. 1974 actually saw a sharp low in October followed by a rally that lasted into November before we plunged to our final lows in December 1974.

Back in 2002 we had a huge plunge into July, a sharp rebound into August and the final plunge into October. Even that wasn't the end of the bear as we rallied once again through November to January 2003, than had one final plunge for a higher low in March 2003.

We are showing a chart of that 2002-03 market as it is an excellent example of lows followed by rebounds, then lower lows, then a rebound and a higher low. We are not suggesting that this one plays out exactly the same way, but we do believe that we could see some ups and downs over the next few months before we make either a lower low or a higher low, then rally later in 2009.

If this collapse is more like 1907, 1937/1938 and 1973/1974 the rally could fool a lot of people. The 1908/1909 bull added 89 per cent to the 1907 lows; a 60 per cent rally in 1938 followed the March 1938 lows before war caught up to the market in 1939; a 53 per cent rally from the December 1974 lows followed into 1975.

From the aforementioned 2002 lows the market rallied 40 per cent into highs in February 2004. Investors also might want to consider that the NASDAQ 2000-2002 fell 77 per cent which compares favourably with the DJI collapse of 1929-1932 of 89 per cent. The rebound rally of the DJI from 1933 to 1937 recouped just under 50 per cent of that collapse. The NASDAQ 2003-2007 recouped about 43 per cent of its collapse.

Despite all the problems greeting Obama as he assumes his presidency (he enters office on January 20, 2009) there are a number of positives developing. Setting aside the probability that unemployment has probably not yet peaked, we can list these as follows:

Our charts below show M1 and M2 monetary growth from a year ago. We show a similar chart for the Dow Jones Industrials. We note that huge increases in monetary growth are soon followed by a jump in the stock market. Note the period around 1983, when M1 and M2 jumped around 13 per cent. The DJI had a big jump in 1983 but faltered in 1984 as monetary growth also slowed. This sparked another big increase in monetary growth and the stock market rose sharply through 1985 to its peak in August 1987.

The late 1980s and early 1990s also witnessed declining monetary growth, particularly M2 (and M3 during that time). When monetary stimulus began in earnest once again in 1995-96 it led directly to the stock market bubble of the late 1990s.

The stock market peaked in early 2000 and already monetary growth had slowed considerably. The collapse of the stock market into 2001 led directly to another huge spike in the monetary aggregates, and that eventually led directly to the next bubble that manifested itself in the housing bubble. The stock market also began to rise starting in 2003, a good year or more after the spike in M1 and M2. The increase in monetary growth peaked around 2004 but it took another two years for the housing bubble to peak. The stock market peaked in 2007. From 2004 to 2007 the monetary aggregates grew at a much slower rate.

The recent stock market collapse has led to another spike in growth in monetary aggregates, plus an unprecedented jump in the monetary base. We suspect that aggregate growth in M1 and M2 will have to go well above 10 per cent in order to bring about the desired effect. As to the monetary base, we have never seen anything like this. But we expect once again after a lag that the stock market will rise and another bubble will form.

This leads us to the conclusion that while the first impact of the recent collapse will be deflationary ultimately the huge monetary stimulus will bring about another inflationary bubble.

Guessing what will benefit in the next bubble is difficult. The first huge burst of monetary growth created the high tech/dot-com bubble. The second gave us the housing bubble and the huge growth in leveraged buyouts and derivatives.

So what will be the next bubble? We suspect it will be gold and precious metals in conjunction with a collapse of the US dollar. We could be wrong, but given what has taken place thus far and seeing growth percolating in the monetary aggregates already, plus the unprecedented growth in the monetary base, we think that gold will be the beneficiary.

We have often noted what may be an 8.5-year cycle of lows for gold (Ray Merriman - The Merriman Market Analyst www.mmacycles.com). There were distinct lows in Gold in 1976, 1985, 1993 and 2001. This targets the next 8.5-year cycle to occur somewhere between March 2008 and August 2009. It appears that the 8.5-year cycle has unfolded and the price last March of $1,015 an ounce was the crest of the cycle.

The current 8.5-year cycle appears to have unfolded in three phases of roughly 34 months. Our first 34-month cycle bottomed in April 2004 36 months after the April 2001lows marked (a) and our second one bottomed in October 2006 30 months after the April 2004 lows marked (b). (Note: We erroneously thought our 34 month low was June 2007 a higher low thus throwing us off and also demonstrating the trickiness in predicting these things). The break of the 17-month moving average confirmed that we were falling into the 8.5-year cycle low. Our next 34-month cycle low is due ideally in August 2009 but could range from April 2009 to October 2009. So while there may be more work to do on this gold bear market, we suspect it should be absolutely finished by July to October 2009.

In the interim gold is oversold sufficiently that a rebound rally should soon get underway. If we are correct on this it will find resistance at $825 and again at around $900. We probably won't see new highs in this move. But once we complete our 34-month cycle low we should embark on a spectacular move up in the next 8.5-year cycle phase. The last 25-year cycle low was seen with the lows of the 1999 and 2001. The next 25-year cycle phase should peak in its second 8.5-year cycle. It will be during this period that gold takes off to $2,000 and possibly higher. The cause will be the huge stimulus provided by the authorities to get the economy out of this mess accompanied by a decline in the value of the US$.

We can't help but notice that Paul Volcker is an economic advisor to Barack Obama. Mr Volcker became Fed chairman in August 1979. Gold topped in January 1980, at $850 an ounce. As a result of Volcker's high interest rate policy the US$ reversed its downward trend and directly led to gold's collapse. Wouldn't it be ironic if Volcker were to be involved once again with US monetary and fiscal policy, only this time having the opposite effect on Gold. History sometimes has an odd way of repeating itself - in the opposite manner. Welcome Obama!

Note: Chart created using Omega TradeStation. Chart data supplied by Dial Data.

 


 

David Chapman

Author: David Chapman

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