The FTSE-100 rose from 5000 to 5500 in February to October 2005. The index then shot up another 500 points to 6000 in March 2006, just five months later. The bull market appears to have advanced at an accelerated rate in recent months.
Many investors find it difficult to invest with caution when so much money is being made. But history offers an important warning signal about current stock market conditions. The reason is linked to the US presidential election cycle.
Unlike the irregularly scheduled British system, presidential elections are held every fourth year in November. The winner starts his four-year term the following January. The last American election was held in November 2004. America is now in year two of the current four-year cycle.
The predictable length of each election cycle directly affects America's economic cycle, with knock-on effects on stock markets throughout the world. The reason is that presidents are like every other politician on the planet. They like to win elections.
It is standard practice for the president's team to attempt to create positive economic conditions when voters step up to the ballot box on election day. In economies as large and complex as America’s, these actions must be taken well in advance to achieve a desired effect at a desired time.
Think back to the low interest rates, tax cuts and deficit spending in the run-up to the last election for a recent example of this pump-priming process in action.
The forward-looking stock market typically reacts in advance to these economic stimulants in years three and four. British shares rose 11 times in a row in the third year of a cycle during the last four decades. Prices increased during year four in 10 of the last 11 election cycles. (Years three and four of the US presidential cycle are next due in 2007 and 2008.)
Unfortunately, boosting the US economy with tax cuts, low interest rates or excessive spending often creates knock-on effects. Economic problems are sometimes created. These chickens often come home to roost a few years later. It helps to explain why the stock market often disappoints investors near the start of a new election cycle. By way of example, the FTSE-All Shares index rose just 25 per cent of the time in the last few decades during the first year of a new presidential term and 44 per cent of the time in year two.
Statistics like these help to explain why bear markets appear so often near the start of a fresh presidential cycle. Since 1961, there were 11 presidential cycles. The UK stock market suffered a downturn near the beginning of seven of those cycles that hit prices by at least 20 per cent. Painful corrections in the 16 per cent to 18 per cent range occurred in two other years.
Some of these downturns began in year one of the cycle. Others began in year two. But each of the nine downturns bottomed out at some point in year two.
As far as the current cycle is concerned, the stock market has been booming…so far. Shares rose 18 per cent in 2005 and another eight per cent the first four months of this year. If history is any guide, a downturn is overdue.
As experienced investors are well-aware, there are no guarantees in the world of investing. The fact that something usually happens does not mean it absolutely will happen this time around. Even so, if history is any guide, the odds for a bear market in the near future are growing. Invest with caution in the months ahead.
To sign up for an email alert when a new Expert Commentator article appears click here.