Presidential Election & Fed Cast (Temporary) Pall over Market
By: Jeffrey Hirsch & Christopher Mistal
November 01, 2016
[Editor’s Note: Please register for Jeff’s Webinar, 50 Years of Election Handicapping, Plus How to Deploy Tactical Seasonal Sector Rotation & Stock Trading Strategies scheduled for Thursday Nov 3, 2016 at 1:00 PM EDT at:  

Celebrating the 50th Anniversary Edition, of Stock Trader’s Almanac 2017, Jeff looks at the impact of the upcoming Presidential Election on the market today, and how to position yourself for Q4 2016 and beyond. The Election Cycle sets up poorly for 2017-2018. Jeff expects a bear market could take the market 20-30% lower into 2017-2018. Then his 2010 Super Boom forecast kicks in, pushing the Dow to 38,820 by 2025. Learn sector rotation, long and short, using fundamentals, technicals, seasonality, cyclical trading strategies, economic trends, and historical patterns pinpointing high-probability setups for stocks and ETFs.]
October did live up to its reputation of being weak in Election years. For S&P 500 October’s 1.9% decline was its second worst monthly performance this year and it was also the third consecutive down month. DJIA has also declined in three straight months. NASDAQ and Russell 2000 suffered the most damage in October, off 2.3% and 4.8% respectively. October’s poor performance in presidential election years has historically been accompanied by an incumbent party loss since 1952 (see page 28 of Stock Trader’s Almanac 2016). In the following chart the 30 trading days before and 60 trading days after the last 16 presidential elections are plotted.
[S&P 500 Performance Before & After Presidential Elections since 1950 Chart]
In the above chart, Election Day is Day 0. Prior to 1984, the market was closed on Presidential Election Days so the close on the day before was used. Since 1984, the close of trading on Election Day was used. Day 26, to the left of “0” was the first trading day of October in 2016. As of today’s close, S&P 500 is suggesting an Incumbent party defeat. It is also noteworthy to observe weakness across all three lines between 10 to 5 Trading days before Election Day and then a rally from right around 5 Trading days before to Election Day.
But the majority of polls still show Democrat Hillary Clinton besting Republican Donald Trump a week from today. This still holds true today even after the FBI announced it may have further information to review and consider regarding Hillary Clinton’s use of a personal email server. Perhaps, the market is actually less concerned about the election and more concerned about the Fed. Economic data has been improving and the labor market has remained firm. The initial estimate for Q3 GDP came in at a consensus beating 2.9%. Unemployment is 5% while monthly job gains have been solid. Inflation may still be below target, but it appears to be trending higher. Data firming, inflation trending in the correct direction and a Fed that seems eager to raise rates does add up to a high probability of a rate increase in December.
Further evidence of a pending rate hike can be found by examining the U.S. dollar index. It briefly touched 99 last Thursday, its highest level since January. The prospect of higher rates has also put pressure on bonds with Treasury bond rates steadily moving higher throughout October. Interest rate sensitive sectors of the market have also been behaving like a rate increase is coming. Financials improved in October while Utilities, Telecom and REITS declined. The market’s recent behavior seems more consistent with positioning for a rate increase within the context of a “different” Presidential race. 
Once Election Day passes, political uncertainty should subside and no matter who claims the White House, Congress will most likely remain split resulting in at least two more years of gridlock. The end of political uncertainty is also coinciding with the market’s strong historical tendency to rebound briskly following three straight down months. Coupled with the start of the market’s “Best Six Month”, November to April, there is a strong case to remain committed to being long per our Tactical Seasonal Switching strategy.
Three Peaks and Post-Election Year 2017
However, the Three Peaks and a Domed House Top Pattern we have been tracking since the beginning of summer suggests an inauspicious future for the market. That’s not to say it’s a foregone conclusion that the market has topped out and will playout in textbook fashion with George Lindsay’s Basic Model shown below. 
This current Three Peaks lines up quite well with Lindsay’s Basic Model. The Three Peaks section lasted just 8 months from Peak 1 (point 3) in February/March 2015 to Peak 3 (point 7) in October/November 2015, falling right in the 8-10 timespan of the Model.
The Domed House top time frame in the Basic Model is about 7 months from the end of the Separating Decline at point 14 to the top at point 23. From the Separating Decline low in February 2016 that would have put the top sometime around or after September. But the current mid-August top is not out of line with historical examples of this pattern. We have seen this phase of the pattern transpire in much shorter and longer time frames.
After the Domed House Top, the pattern resolves at point 28, somewhere back around points 10 and 14 at a minimum. It can go substantially lower before a new high, which could culminate in a bear market. On the flipside, the more likely scenario at present with market, political and economic conditions as they are mentioned above, is that this pattern can still play out in its entirety, while the market rallies after the election through yearend and the Best Six Months. 
Even if it does complete at just the minimum level the approximate 15% drop would not be a bear market. It’s just something we have our eye on and wanted to be sure all Almanac Investors and Traders were aware of the risk suggested by this pattern.
Point 27 has also been recorded in the past at higher levels than point 23 and has taken several months to play out. As the economy firms up and the election is over we expect seasonality to take over and drive stocks higher, but next year is another story all together. 
As the Fed begins to tighten and rates rise and the new president completes their first 100 days look for the market to soften further as post-election year forces get stronger and the Best Six Months comes to an end in April.  At which point we may find ourselves entering bear market territory. For now, after three down months in a row, we expect a rebound.