The summer of stock market discontent may have started early, with a negative first quarter perhaps anticipating the May-November span, which is historically the worst six-month period for equity investors.
Next month also begins the half year leading up to the midterm elections, the weakest six months for stocks in the presidential cycle. And the worst of these, according to the Stock Trader’s Almanac, occurred during the first term of office for Democratic presidents.
And that’s before considering the expected further tightening of Federal Reserve policy.
Given all of these negatives, you’ll probably give it a positive spoiler alert. That lousy half-year stretch has historically been the prologue to the best six months of the four-year political cycle.
The old phrase “Sell in May and go away” sounds like something out of the Farmer’s Almanac. But looking back to 1926, the
S&P 500 index
has posted an average total return of just 2.2% in the second year of a presidency from May through October, writes Doug Ramsey, Leuthold’s chief investment officer, in the company’s April report, known as the Green Book for Wall Street professionals. It was the worst half-year for equities. In stark contrast, the subsequent period from November to April, which extends into a president’s third year in office, was by far the best, with an average return of 13.9%.
For small-cap stocks, the pattern is even more pronounced: an average May-October mid-year decline of 2.5% was followed by an average November-April rise of 19.2%, Leuthold data shows.
Looking at recent history, Strategas Research Partners’ Washington team, led by Daniel Clifton, found that since 1962, stock sell-offs have tended to be larger during the midterm election years. If there were losses in those years, they averaged 19%, compared to 13% in the non-intermediate years. But after large medium-term declines, the market recovered an average of 31.6%.
This pattern can be traced back to politics, the Strategas note argues. Monetary and fiscal policy tends to tighten and “we eat our spinach in the middle of the year” before markets expect policymakers to hand out candy to boost the economy in presidential election year.
Ramsey has a slightly less cynical theory: Disenchantment with a new or newly elected government tends to set in in the second year in office, and investors register their frustration ahead of the November election. That, in turn, forms the strongest six-month range for stocks in the four-year cycle.
Additionally, Ramsey suggests that many of the steep intermediate-term declines were “bear killers” that marked peaks of longer-term declines. Of the 14 S&P 500 declines of 19% or more since 1960, 10 bottomed in a mid-election year, with eight bottoming in the seasonally weak May-October span, including the big bear lows of 1974, 1982, and 2002.
Most intermediate-term loss years started with negative first quarters, observes Jeffrey Hirsch, editor of Stock Trader’s Almanac. This year, the S&P 500, Dow Industrials and
all fell into this period. “These years have an eerie resonance to what is happening today in 2022. War, conflict, inflation, recession and rate hikes were common themes during these mid-term years,” Hirsch wrote in a note to clients.
Seven out of ten mid-election years since 1938 that began with negative first quarters ended in negative territory. Exceptions were in 1938 with the recovery from the severe economic downturn in 1937; 1942, with the turning point of World War II at the Battle of Midway; and 1982 with the start of the secular bull market.
So how do you weather a long, hot summer for stocks?
Maybe with bonds. After March and April, the seasonally worst two months for the government bond market since 1990, the May-September period has produced the best returns for the benchmark 10-year bond, according to a client note from Bianco Research’s Greg Blaha. He does add a note of caution given the relatively small sample, which he nevertheless found to be more representative than data going back much further. And inflation, pandemics and war can provide plenty of short-term volatility.
If history repeats itself, this summer should be an uncomfortable one for stock bulls. “Valuations in stock markets still look extremely high and the Fed has only just begun to hike rates,” Ramsey writes. “But the cycles say an ideal window for a big low is about to open.” Just don’t jump through too soon.
Read more Up and Down Wall Street: Finally, the entire Fed chorus is singing out the same anti-inflation chant
write to Randall W. Forsyth at email@example.com