One of the biggest forces at work in the market right now is not GDP, consumer confidence or any economic measure. The release of those numbers will influence the market for a short time, but the big, long-term direction of the market is being dictated by the presidential election cycle. We’ve just crossed over to the third year of the four-year cycle, and this is the most critical and most predictable 12-month period in the cycle.
As you can see from the chart below, history shows us that this is by far the strongest year — every third year of this cycle has been up since 1955. With the market starting January on a strong note, clearly history is repeating itself, and we’ll likely have smooth sailing through at least the first half of this year (stocks historically tend to be strong until early summer).
The reason why the third presidential cycle years tend to be up is because the party in power tries to do everything it can to get re-elected. With all of the campaigning and positioning that will happen this year, not a whole lot of actual legislation will get passed, and political gridlock will take hold. Add to that the fact that Democrats could not keep Congress, and the split of power is even better for us.
As you know, businesses and the stock market love gridlock. When you own a business, you’re less likely to expand or spend when you’re not certain if new laws will come in to change the game. When you’re reasonably certain that the landscape won’t change, you have the confidence to venture out into new areas. As you can see, in the end, political gridlock may turn out to be even better for the stock market.
With a better environment for spending and expansion, we’re going to see the nearly $2 trillion of cash sitting on corporate balance sheets come into play. We will see that cash go to work in 2011, and drive the market higher. Just like cash can burn a hole in consumers’ pockets, it does the same thing in corporate America, which is itching to spend much of their cash as their balance sheets become increasingly bloated.
The first and easiest decision is for many companies to continue to buy back their outstanding stock, which helps their earnings per share rise even further. The second decision is to redeem more expensive debt. The third decision is to go on a buying spree and buy competitors and to venture into new businesses. As a result, “merger mania,” which started back in August, is expected to remain alive and well for the next several months.
As you can see, there are a lot of positives working in the market’s favor right now and smart investors have every reason to be fully invested. But what I want you to know is that while the presidential election cycle is a positive for the market, February typically brings higher volatility into the equation. Don’t get rattled by this.
If you smartly stake your claim in fundamentally sound companies and don’t let the increase in volatility push you out of your stocks, you’re going to find yourself in a very happy place.
