2012 Could Be a Good Year for Stocks

The election may serve as a better forecast for stocks—and vice versa—than any of the other news occupying investors’ minds today, writes MoneyShow.com editor-at-large Howard R. Gold.

Greece is burning, Italy’s imploding, and the US economy is limping along in a recovery so weak it’s barely stronger than a recession. And investors are reeling after Wednesday’s sell-off in stocks, gold, the kitchen sink…what have you.

But next year may turn out to be pretty good for stocks.

How can I say that? Because from here on, the market’s historic calendar is in investors’ favor. And if we can stay out of recession in the US and avoid one in the developing world, earnings of US-based companies may hold up well enough to support somewhat higher stock prices. (A recession in Europe is already baked in the cake.)

Most of all, 2012 is a presidential election year. Since 1948, markets have gained in every single election year except for two—2000 and 2008. In fact, stocks have on average put in their second best performance in the fourth year of a president’s term. (The third year has been best.)

And during years in which incumbent presidents run for re-election, the market has beaten its average election-year performance significantly.

It doesn’t matter if the incumbent wins or loses (though no investor can know that in advance) or how good or bad a president he was. The market just has done better in “incumbent” election years than in “up for grabs” elections, like Bush v. Gore in 2000 or McCain v. Obama in 2008.

The data are remarkably consistent.

According to Sam Stovall, chief equity strategist for Standard & Poor’s Capital IQ, the S&P 500 index posted average returns (not including dividends) of 5.7% during all presidential election years from 1944 to 2008.

The Stock Trader’s Almanac, using the Dow Jones Industrial Average and earlier proxies, calculated nearly identical presidential election-year returns of 5.8% from 1832 to 2008. (The Dow itself averaged 7.4% annually in election years from 1900 to 2008, according to the Almanac’s figures.)

And I looked separately at years in which an incumbent president was running for re-election. It didn’t matter if the president was running after a full elected term, like Ronald Reagan, or took office after the death or resignation of the previous incumbent, like Lyndon Johnson or Gerald Ford.

The results? In the 14 elections since 1928 that included an incumbent president, the S&P 500 rose an average of 14.6%. In all the “incumbent” elections since 1900, the Dow gained on average 9%—substantially besting the averages’ performance during all election years.

When he heard these results, Stovall said: “People feel more comfortable that at least you know how to drive the bus. You’re not facing [one of] two people taking over who lack total experience.”

In other words, one devil you know is better than two you don’t.

• Read Howard’s take on the problems with the Republican presidential field on The Independent Agenda.

Stovall, incidentally, is pretty bullish on the market for the rest of this year as well as next year. He wrote that the S&P “barely escaped” a bear market when it closed at 1,099.23 on October 3 and then bounced back strongly, “suggesting the bull market is still alive.”

Research he’s done on the four severe corrections (15% to 20% declines) and the four mini-bear markets (20% to 25% sell-offs) since 1945 indicates that “the S&P 500 gained an average 23% in the six months after these eight market bottoms…[and] was higher by an average of 31.7% a full year after these market declines had run their course.”

So, it’s not surprising that S&P’s Investment Policy Committee recently raised its 12-month target for the S&P to 1,360 from 1,260 (where it closed Monday).

NEXT: Will the Calendar Work in 2012?

Jeffrey Hirsch, editor in chief of the Stock Trader’s Almanac, also looks for 2012 to be a good year, based on the calendar.

I asked him the question I posed in last week’s column: Can we still trust these patterns given how big a role hedge funds and high frequency traders play in the market? He said things had gotten out of whack in the two years after the financial crisis, but “then, when the dust settled, they began to work again.”

• Read Howard’s analysis of why it’s hard to outguess a broken market.

“Despite all this high-frequency trading and craziness and volatility, these seasonal patterns continue to deliver,” he observed. “This year has been a textbook year seasonally for the stock market,” because it peaked at the end of April and bottomed in October, he pointed out.

He’s bullish because we’ve entered the traditionally strongest six months of the stock-market calendar (from November through May), but he isn’t looking for fireworks.

“I don’t think we’re going to break out to new highs” near 12,800 to 13,000 on the Dow, he said. “There’s a lot of overhead resistance.”

I expect this column to get a lot of resistance, too. In fact, I’m surprised I’m writing it.

I turned bearish in the spring just as the market was topping out. I’ve been cautious ever since, expecting stocks to go lower still.

• Read Howard’s early warning about why investors need to be cautious.

But when the S&P 500 hit its low on October 3 and then bounced back strongly, it looked as if the index had successfully tested a solid, long-term support level at 1,100 and that the worst of this correction or mini-bear market was over.

Now, that rally is looking shaky. The prime ministers of Greece and Italy have resigned, and investors are waiting to see if those two dysfunctional governments accept the austerity programs the European Union has demanded. Meanwhile, Italian government bond yields have risen near a point of no return. Italy, however, is truly too big to fail.

Anybody who tells you he or she can predict what will happen next is smoking too much of something.

So, if you’ve still got any risk tolerance left, I’d wait to see how low stocks go during the current sell-off. If the S&P doesn’t fall below its new support around 1,190, then it might be okay to put some money— and I mean no more than 10% of your assets—back into the market. If 1,190 doesn’t hold, I’d wait for another retest of 1,100 before putting any money to work.

Oh, one more thing: Hirsch says the stock market’s performance can be a good predictor of who will win the election.

Since 1901, during the 15 times the party in the White House was re-elected, the Dow was up 1.5% in the first five months of the year. When the party in power lost, the Dow was down 4.6% during the time.

So, forget the primaries and caucuses that will soon be upon us. Next year, not only investors but also political insiders could follow the markets closely. Because in 2012, stock-market returns may forecast election returns better than any public opinion poll.

Howard R. Gold is editor-at-large for MoneyShow.com and a columnist for MarketWatch. Follow him on Twitter @howardrgold, read more commentary at www.howardrgold.com, and catch his political blog at www.independentagenda.com.