All Clear!

Now that we’re on the other side of the election, we can take stock of how the great big uncertainty is finally removed, and everything is clear.  That probably doesn’t sound wholly accurate, does it?  All we know is that Washington will be divided when new Congresspeople are sworn in in January (despite numerous races still not called).  But to say that we know for certain the level of bipartisanship that will take root, or whether business confidence and consumer confidence will change, or how many White House investigations the House will be ordering up, or how our mercurial president will react, that’s a really big stretch.

Market prognosticators, ourselves included, bear some guilt for talking up the now-suddenly well-known statistic that, since 1950, the stock market has always gained in the 12 months following a midterm election.  17 for 17.  The average gain for the S&P 500 over those 12-month periods has been +15%, considerably higher than the long-term annual average gain of 7%.  Plus, the 4th quarter is generally very kind to investors.

It’s hard not to fall in love with those statistics.  As this precedent has “gone viral” among the financial media, it has taken on a new life as a sort of backstop for the stock market, a reason to look ahead through the malaise of October to greener pastures on the other side of the election.  Again, we are as guilty as the next guy in bringing this to the attention of our customers.  That said, because we’re contrarians, we’ve begun to wonder whether this opinion has become consensus.  Because we know that when an opinion is universally shared among the consensus, the opposite comes true, pretty much every time.

By now it might seem like we’ve changed our minds on whether the market is going to go up or down about 4 times just since this post began.  Let us go on the record as saying that we still believe the most likely direction for the stock market is up, and the reasons are myriad.  The U.S. economy is still strong, wage growth is starting to finally rise but hasn’t risen to the breaking point for corporate America, capital spending has taken off this year, stock market valuations are still cheap compared to bonds, and stocks remain underbought this cycle.

But it wouldn’t surprise us if the next 12 months play out slightly differently than a normal post-midterm election.  Many concerns linger, and these are shared by the consensus, not just us, so they might very well be priced in.  The Fed seems to be fixated on a path to raising rates faster than the bond market is prepared to accept.  Relationships with our allies are still fractured, nationalism is still on the rise globally, and the trade war with China looks to be endless.  Globally, economic growth is slowing, partly in response to the retracement of free trade, especially in China.  And our country is every bit as divided as it was before the election.  If anything, the election served as a reminder of just how entrenched our two parties have become, and how the hollowing out of the political middle continues unabated.

Again, we still think the eventual path will be upward.  But there is another interesting statistic about those 17 post-midterm election periods.  At some point during the 12 beautiful months, the stock market drops 11.3%, on average.  It could be right after the election, early in the following year, or in the fall of the following year.  Despite that sharp drop, the market eventually works its way back up into the black for the November-November period.  The one major exception was in 1986-87.  The market rallied strongly before the infamous crash of October, 1987, known as Black Monday.  The market had performed so well before the crash that it eked out a 2% gain for the 12-month November-November period.  The second worst correction in post-midterm periods was after the 2010 midterm election…in August, 2011, when the market fell 20%.  While that was a long time ago, it was already 2 ½ years into the current bull market!

Which reminds us that we are in Year 10 of this bull market, by most measures now the longest-running bull market ever.  Cycles don’t last forever.  While we see good reasons to believe that the bull market has not yet ended, we also know that volatility in the stock market increases as bull markets age.  Look no further than the 1990s.  Sharp stock declines became a regular occurrence between 1997 and 1999, even as the stock market posted annual gains of 20%+ every year.  Amidst those corrections, tech stocks always fell way more than the market.  The sharp correction in high-flying tech stocks in October was eerily reminiscent.  It’s noticeable that safety stocks, many of which are among Monarch’s core stocks, have performed well in the last few months.

So, if there’s a coherent message in this, be prepared for a wild ride!  As you should always be!

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