September wasn’t kind to investors…
The blue-chip S&P 500 dropped 5%.
That was the worst month for the index since last December.
And to make matters worse for stock market investors, yields in the Treasury market have hit their highest levels in more than a decade.
You can now pick up a yield of 5.5% on a 1-year Treasury bill with virtually no risk. That’s up from a 1.6% yield in March of 2022 when the Fed started to raise interest rates.
And higher Treasury yields are a headwind for stocks.
First, when Treasury yields rise, it pushes up mortgage rates, corporate bond yields, and credit card interest rates. This chokes economic growth.
Second, when investors can earn north of 5.5%, with very little risk, on 1-year T-bills, this draws money out of stocks and into bonds.
But remember that the S&P 500 rose 16% in the first half of 2023. That compares with an average 12% yearly gain for the index going back to 1957.
So, some pullback after this outsized move higher makes sense.
And as we’ll look at today, there are also cycles and seasonal trends that point to a strong finish to the year for stocks.
First, we’re in the most bullish part of the Presidential Cycle…
This cycle first rose to prominence in the 1960s.
It’s the brainchild of Yale Hirsch. He’s the American newsletter writer best known for founding the Stock Trader’s Almanac in 1966.
It contains a wealth of historical market data, seasonal trends, and trading patterns. And it quickly became popular as a must-have resource for investors.
The idea is that U.S. stock market performance follows a recurring four-year cycle that tracks with the four-year term of a U.S. president.
Here’s how it breaks down…
Year 1 – Typically, the first year after a presidential election is the weakest for stocks. That’s because a new president might come in with a mandate for change, which could include policy shifts that generate uncertainty. And investors hate uncertainty.
Year 2 – Things start to pick up. The administration starts to implement its policies, and the uncertainty surrounding those changes begins to wane. Any tough economic measures would ideally be implemented early in the term to allow for recovery before re-election campaigning kicks off.
Year 3 – This is usually considered the best year for the stock market. It’s the lead-up to the next election year. So, there’s often a focus on bolstering the economy to improve re-election odds.
Year 4 – Also generally a positive year, but it can be mixed. It’s an election year. So there’s that renewed uncertainty. But sitting presidents do their best to stoke the economy for re-election.
If you’re like most folks, you’re probably sick of politics. And I don’t blame you. But the cycle is worth paying attention to.
Right now, we’re in the most bullish year of the cycle…
Going back to the start of 1945, the S&P 500 has risen an average of 15.9% during the last full year before an election compared with an overall average of 9.2% for every year.
And the last time a president was in the third year of his term – in 2019 under Donald Trump – the S&P 500 soared nearly 29%.
Now, this cycle doesn’t have a perfect track record. For instance, in 2011 – the third year of President Barack Obama’s first term – the S&P 500 ended the year flat.
Despite that, investors usually expect the president to try to ensure re-election by stimulating the economy. And this feeds a more bullish tone to the stock market in pre-election years.
And that’s not the only reason for optimism.
The fourth quarter tends to be the strongest part of the year for stocks…
Figures from advisory firm Carson Research show that stocks rally about 80% of the time in the October-to-December quarter.
That may be due to several factors, like an autumn pullback setting the stage for a year-end rally.
Or it could have to do with investors slowing down their investments going into the end of the year and the market simply trends higher.
Either way, the market’s average gain is about 4.2% in the fourth quarter.
That compares with an average gain of 2.1% in the first quarter… 1.9% in the second quarter… and 0.7% in the third quarter.
So, if history is any guide, things should be looking up soon in stocks as we close out the year.
So, now is not the time to panic sell your stocks…
Yes, higher Treasury yields are a headwind for stocks. That’s something we’ll be returning to in future dispatches.
But the Presidential Cycle and the tendency for the stock market to have a strong close for the year paint a more bullish picture.
But it’s no time for complacency.
With borrowing costs rising, now is a good time to run the rule over the stocks in your portfolio and cut loose stocks in companies that are carrying a lot of debt relative to the cash they’re bringing in.
One quick way to do this is to calculate a company’s “current ratio.” This tells you its level of current assets to liabilities due in the next year.
To calculate it, simply divide a company’s current assets by its current liabilities – both of which can be found on the company’s balance sheets. A website like Bankrate.com can also calculate it for you.
A ratio of 1.2 to 2 is considered healthy.
Anything less than a 1 could lead to problems. It means the company doesn’t have enough assets to cover its liabilities for the next year. That puts it at higher risk for liquidity problems, which could tank shares.
Focusing on companies with stronger balance sheets will help you avoid this risk.
Regards,
Chris Lowe
Editor, The Daily Cut