Top Advisors Corner

Tom McClellan: A Different Sort of Presidential Cycle


It is by now an overused phrase to say that we are in a different sort of presidency right now.  And befitting that theme, we are seeing a really different sort of behavior of the market relative to the Presidential Cycle Pattern.

This week’s chart shows a version of our Presidential Cycle Pattern that is constructed by averaging together the stock market’s performance only in periods when there is a new president from a different party than the last one.  We have found that the market’s personality differs quite a bit according to whether there is a new sheriff in town from a different group than the last one, versus a status quo type of president. 

Normally a new president from a different party brings a market rise, at least until May of the first year, just on hope that everything is going to be better.  Then as investors realize that all of their hopes are not getting realized right away, that hope turns into disappointment, and the market declines during the summer and into autumn. 

What we are seeing this time is a rise, all right, but it is continuing now into July, and investors are not yet showing disappointment.  That’s a verbal story.  But if you look closely at the chart, you can see that the SP500 has been zigging and zagging all at the wrong times, according to the Pattern.  In other words, the correlation has been inverse.

But that statement is only true when one looks at a certain time frame.  The overall path of the SP50 has been higher like it was supposed to, but the minor pattern has been inverse. 

This revisits a point I wrote about in August 2010, under the headline of “Correlations May Not Be What They Seem”.  The point is that having a trend in the data makes an inverse correlation seem positive, both visually and quantitatively.  Here are a couple of charts from that article.  The first shows a perfect inverse correlation:

But if we add an artificial uptrend to that inversely correlated data, the calculation of a correlation coefficient flips to a strongly positive one:

The point in reviewing these principles is to see past the 8-month uptrend in the first chart, and notice the inverse relationship in the smaller movements, even as there is an overall uptrend.  That overall uptrend can disguise the inverse movement on the shorter time scale. 

With that point firmly in mind, we can see that the SP500’s movements have been backwards from what the schedule says.  There is your different sort of presidency, and different sort of price response.  The SP500 bottomed at the end of June, just when this Presidential Cycle Pattern said that a minor top was supposed to be seen.  And now the market is rising at a time when the Pattern says prices should be falling.

All of this inverse behavior would be concealed from those who look just at quarterly or monthly returns data.  You have to look at the chart closely to see the insight.  And the immediate message is that prices should continue higher for much of the rest of July.  A longer term chart shows that this autumn will get even more interesting, assuming that the inverse correlation of the minor patterns remains inverse.

If it does remain inverse, then the Pattern’s decline into late September should mean a strong advance for stock prices then.  But here is the caveat: If you ever count on a relationship remaining inverse, that’s when it can flip again and fool you.  So you must keep a watch on it, and notice if it “disinverts”.

Tom McClellan 
The McClellan Market Report

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