Election Cycles and Inverted Yield Curves
From my favorite fund manager and market commentator, Dr. Hussman:
"Since July, we've observed an inverted yield curve, with the 10-year Treasury yield below the 3-month Treasury bill yield. Bill Hester observed last week that whenever the Fed has raised the discount rate by at least 1%, ending in a yield curve inversion for more than a few weeks, the U.S. economy has entered a recession after a median lag of 8 months. We can't rule out the possibility that the current yield curve inversion will be followed by further economic growth, but such an exception would be outside the oval.
"On the valuation front, the current P/E ratio for the S&P 500 is 18 times record earnings (on record profit margins). Historically, the combination of an inverted yield curve and a P/E ratio over 15 has been associated with negative market returns, on average. The current observation, moreover, is even further outside the oval. The only time we've observed an inverted yield curve and a P/E at or above 18 times record earnings was at the 2000 market top. The runner-up (just below 18) was near the heights of the “Go-Go” market leading into the '69-'70 bear market."
BUT WHAT ABOUT THE ELECTION CYCLE?
" there's a distinction between analysis and superstition. Wall Street is littered with the ruins of people who mined for patterns in the data and invested on them without knowing why they should work. In terms of the 4-year cycle, the typical explanation for the strong seasonal returns is that fiscal and monetary policy often become accommodative during this part of the Presidential term. That was certainly the case in late-2002 and 2003, but isn't quite so likely here.
"Beyond that, there are other factors at work. In 12 of the 15 cases, the S&P 500 had been at least 10% below its prior 52-week high within several weeks (and no more than 6 months) before the seasonally favorable period. At present, the market is strenuously overbought, and long overdue for a 10% correction.
"Of the 11 recessions in the post-war period, 9 were in force a year or less prior to the seasonally favorable period. Evidently, the majority of the strength was linked to post-recession recovery momentum.
"Only 4 of these periods began at P/E ratios above 15 on the S&P 500, and of those, none began with the S&P 500 above its 6-month moving average (as it clearly is at present). Once again, you generally build sustained rallies off of prior losses, not off of overextended advances.
"Of the 9 cycles since 1963 (when Investors Intelligence began publishing its advisory sentiment data), all but one began at a lower level of advisory bullishness than today.
"In short, the favorable 4-year seasonal period has a “snap-back” component to it, where the market was typically recovering from a recession, a substantial market drop, or at least a period of consolidation. Indeed, many of the start-years (e.g. 1970, 1974, 1982, 1990, 2002) are familiar exactly because they represented memorable bear market lows."