The Third Year Theme
This, the third year of the presidential election cycle, has historically been very favorable for the stock market. That’s good news as stocks are still having trouble sustaining traction. Led by Apple and Google, the NASDAQ over-the-counter stock average made another all-time high. Meanwhile, the Dow Jones Industrial Average and the S&P 500 slid back toward their levels at the beginning of the year.
The theory behind the presidential cycle is that politicians will do almost anything to keep themselves and their party in office, including managing the economy. This implies that newly elected or reelected presidents emphasize other topics, planning to boost employment, exports and consumer confidence in the second half of their terms.
Correlation does not equal causation but historical data bear out the theory. As Barron’s reported (October 2, 2014), “Since the Dow Jones Industrial Average was created in 1896, the stock market during such years has gained an average of 15%, rising 82% of the time. That’s nearly four times the average gain in all other years of 4.4%. During those other years, furthermore, the market has risen 58% of the time.
The contrast is even starker if we focus on the period since 1940 . . . Since 1940 the Dow has risen in 100% of third years, gaining an average of 22.3%. That contrasts with an average gain of just 3.1% during all non-third years since 1940. In years one, two, and four, the market has risen 57% of the time.”
Arguably, the unprecedented monetary stimulus by the Federal Reserve to rescue the economy from the Financial Crisis may have shifted some third-year strength to the preceding years. Even those these years were quite strong, data since 1896 show that stronger gains actually occurred in third years following such strong years.
This is the third year of President Obama’s final term but past markets have actually gained more during the third years of second terms rather than first terms. With current anxieties stirred up by the media, it’s helpful to reflect that market history favors higher prices for the next few months.
Except for those fortunately rare times when the market is swamped by panicked selling or heedless buying, stocks, like teenagers, are quite sensitive to prevailing influences. Recently, the Greek currency crises and the prospects of Federal Reserve rate increases dominated the news until quarterly earnings season arrived with new company reports.
Apple (AAPL-$125) took center stage. It reported sales of $49.6 billion and earnings of $1.85, both above consensus estimates of $49.4 billion and $1.81. Nevertheless, the critics were hoping for more and this so-called “disappointment” sent its stock down 10%. Apple forecast sales increasing to $49-$51 billion for the next quarter. The company’s forecasts are usually conservative and its profit margins are increasing. It is sitting on $150 billion in cash that, if excluded, lowers its valuation to 12 times earnings.
This alleged “disappointment” took the wind out of most of the tech sector, particularly semiconductor stocks. Among those grazed were ARM Holdings (ARMH-$47), Avago Technologies (AVGO-$131), Broadcom (BRCM-$52), Intel (INTC-$28) and Taiwan Semiconductor (TSM-$22). Illumina (ILMN- $215), the gene–sequencing giant, also missed “expectations” and gave up 10%. All of these, including Apple, are buys, except Intel, a “Hold” requiring patience as it continues to reshape its product lines.
Outside the tech sector, United Technologies (UTX-$101) and Union Pacific (UNP-$93) slipped on mild shortfalls and will need another couple of quarters to resume their price momentum. Upside overachievers with positive earnings surprises included Acuity Brands (AYI-$191), new buy Amerisource Bergen (ABC-$111), Boeing (BA-$147), Bristol-Myers (BMY-$68), Celgene (CELG-$139), Honeywell (HON-$104) and Thermo Fisher (TMO-$140).
The next two weeks will see a flurry of new reports. Analysts previously lowered expectations for many stocks, giving leeway for more positive “surprises.” Improving economic news coupled with the third-year record of the presidential cycle will keep stocks on course.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622
