Cai Jin

Better safe than sorry in US presidential stock cycle

One market trend worth highlighting for anyone wondering what the stock market may hold in store next year is the so-called United States presidential stock cycle.

In a nutshell, this trend suggests that Wall Street tends to put in a subpar showing during the final year of a US president's term, even more so if that president is into the last leg of his second term as he does not have the option of re-election.

A weak Wall Street showing will, in turn, undermine the performance of the rest of the world's stock markets, given the big influence the US wields over them.

Recent history appears to bear out this observation.

The last leg of the eight-year term of Mr George W. Bush, President Barack Obama's predecessor, was marked by the worst financial crisis in decades, as toxic sub-prime US mortgage loans poisoned the balance sheets of banks all over the world.

Although Mr Bush's predecessor, Mr Bill Clinton, enjoyed a booming US stock market during the fourth year of his second term, he left a legacy of bubbles which blew up in a spectacular fashion soon after his departure from the White House.

Even Mr Ronald Reagan, who was president from 1981 to 1989, was not spared. Near the end of his presidency, US stocks suffered a big crash known in history as Black Monday, with Wall Street plunging 23 per cent in a day.

Now, one may ask why the final year of a two-term US president is such a distinct loser.

Conventional wisdom dictates that when a US president is first elected, he uses the honeymoon period of his presidency to push through tough legislation and get the economy to swallow whatever painful medicine is necessary to set the stage for good times down the road, in order to get re-elected.

Given the market's propensity to discount whatever may unfold ahead, this means that the third year of a US presidential term would be good for Wall Street, as investors anticipate the good times that will materialise in the fourth year.

But in the fourth year, the stock market will start to anticipate the economic medicine that needs to be swallowed in the subsequent presidential cycle, especially if the incumbent has been in office for two terms, given his successor's desire to have two terms as well.

To test the soundness of this theory, one would have to determine if Wall Street is having a great time this year - Mr Obama's seventh year in office.

At first glance, this does not appear to be the case.

Wall Street has made only low single-digit gains in percentage terms so far, while markets such as Singapore and Hong Kong are down for the year.

But adherents of the presidential stock cycle argue that the start of Mr Obama's penultimate year was last October, as that marked the commencement of the new US fiscal year, and that the best gains were supposed to take place during the six months from October to April.

(A new president formally takes office in the January after a November election.)

In that case, the theory does have some credence.

Singapore and Hong Kong peaked at multi-year highs in April, while Wall Street vaulted to record levels in May.

Since then, however, it would appear that the eighth-year angst might have come a tad early as one market calamity after another struck stock prices across the globe.

This started with a calamitous crash in the Shanghai stock market in July, a sudden devaluation of the Chinese currency in August and jitters over the reasons behind the US central bank's September move to postpone a looming interest rate hike.

What is also interesting to note is that as Mr Obama coasts into his ultimate year in office, profit warnings and earnings misses are becoming more and more common.

In the current corporate reporting season, companies seem unable to boost their earnings with the usual slew of cost-cutting measures and share buybacks like they used to.

Worse, big names such as Standard Chartered Bank and oil giant Shell are taking an axe to their global staff headcounts to reduce costs.

In the US, oil giants ExxonMobil and Chevron both reported huge drops in third-quarter profits because of plunging crude oil prices, even though their earnings exceeded analysts' expectations.

Elsewhere, AP Moller-Maersk, the world's biggest container shipping group, issued a profit warning, blaming a slowdown in global trade for its woes.

In Singapore, even the three local lenders might be feeling some heat, as they face a slowdown in loans growth despite respectable results.

In the offshore sector, widely-followed rig-builders Keppel Corporation and Sembcorp Marine both reported a drop in quarterly earnings.

Mr Michael Hartnett, Bank of America Merrill Lynch's chief investment strategist who studied the presidential stock cycle, observed in a recent report that the "Wall Street boom, Main Street bust" narrative is one which central banks would like to avoid next year, since it is a US election year.

Still, the narrative may yet unfold. As the two-term presidency finishes, it often flags the end of excessive asset valuations somewhere in the global financial markets, and Mr Hartnett anticipates next year to be another tough one for the market.

While profit misses among mainstream companies may be a concern, Mr Hartnett felt that one big worry is the "speculative blow-off" in what he describes as the excessive run-up in so-called "uber growth" stocks.

These are companies such as Uber, which are not publicly listed, but which are prized more highly with each round of fund-raising from private investors.

Uber, the controversial ride-sharing start-up, for example, was reported to be worth US$50 billion (S$71 billion) after selling new shares to investors, including Microsoft, in its financing round in July.

Mr Hartnett also warned that the bull run built by the central banks may collapse, if a combination of US Fed rate hike and further monetary easing by the Bank of Japan and European Central Bank causes the US dollar to spike, and emerging and commodities markets to swoon.

"December could be the first time since May 1994 (a year of bond crashes and defaults) that investors experience a Fed rate hike and an European rate cut in the same month," he added.

Mr Hartnett's advice to investors as Mr Obama's presidency approaches the home run is to sell into strength.

In other words, it doesn't matter whether Hillary Clinton, Donald Trump or Marco Rubio becomes the next US president.

Investors should adopt a "better safe than be sorry" strategy.

A version of this article appeared in the print edition of The Straits Times on November 09, 2015, with the headline 'Better safe than sorry in US presidential stock cycle'. Print Edition | Subscribe