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A strong market rally could be just weeks away if the US midterm elections can put stock investors at ease.

If this year’s US midterm election cycle is anything like the ones that have passed, the stock market will make an important low right around Election Day in November.

That should offer some hope to overconfident investors, whose stock holders have suffered double-digit losses so far this year. A meaningful rally could be just weeks away.

I am referring to the historical pattern in the stock market of pre-midterm weakness and post-midterm strength. This pattern, plotted in the chart below, is based on the July-December average performance of the Dow Jones Industrial Average.
DJIA,
+ 1.19%

in the last 17 years of midterm elections (since 1954).

Although the date of the average in this chart is in October, the actual low on the historic record could come earlier or later. Much depends on when the stock market starts predicting the outcome of the midterms and therefore discounting it. A good prediction is that this year’s lows will be later, given the uncertainty about election results – especially in the US Senate.

There is always a chance that the midterm low will occur before Election Day. In fact, it wouldn’t contradict the historic record for this year’s low that occurred the day after Labor Day. As of September 9, S&P 500
SPX,
+ 1.53%

4% higher than that low.

It should be noted how remarkable any pattern appears when averaging stock market movements over many years. Although each year creates its own path, the highs and lows often cancel each other out, leaving the average as an upward sloping line. A pattern must be fairly obvious in historical data for deviations to appear as obvious as the pattern in the accompanying chart.

This pre- and post-midterm pattern is so pronounced that it is the origin of the famous seasonal pattern known as the “Halloween Indicator,” whereby the stock market is strongest between October 31st and October 31st. May 1 and the weakest in the remaining six months of the year. However, take away the six months before and after the midterm elections and the Halloween Indicator disappears.

The underlying data appears in the table below. Cells marked with an asterisk

refers to the current six-month period, while the box marked with a double asterisk (**) corresponds to a six-month period beginning in late October 2022.

Year of the Presidential Cycle since 1954

Average Dow gain from Halloween to May 1

Average Dow gain from May 1 through Halloween

first

6.4%

1.5%

2

4.7%

-0.2% *

3

15.1% **

1.1%

4

4.3%

0.5%

So if you want to bet on the Halloween Indicator, your time is fast approaching. If you miss it, you won’t get another chance until midterm 2026. Credit for discovering that the Halloween Indicator tracks the months before and after the midterms goes to Terry Marsh, an emeritus finance professor at the University of California, Berkeley, and the CEO of Quantal International, and Kam Fong Chan, a senior lecturer in finance at the University of Queensland in Australia.Their research on this model appears in July 2021 in the Journal of Financial Economics

.

According to the researchers, the source of this pattern is the uncertainty that exists before midterms and the resolution of that uncertainty after the election. They note that it does not seem to matter which party dominates the National Assembly before the term and which becomes the majority party afterwards. They believe this model exists because the stock market craves certainty, even if the source of that certainty may not be to every investor’s political preferences. Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be contacted at

mark@hulbertratings.com Than:

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