The Election Cycle: What to Expect in Stock and Bond Prices

By Chris Vermeulen  NOV 05, 2012 9:25 AM

If Obama wins the election, it's likely that bond prices will rise or trade sideways while stocks will move higher. If Romney wins, bonds could rally much more and stocks could sell off.


It's that time in the presidential cycle that gets everyone emotional and concerned with the future outlook of the United States. While everyone has their opinion on whom they think is best for America, I promised myself a long time ago to keep my thoughts to myself for two key reasons: 1) only some Americans will agree with me, and 2): I'm Canadian so I do not experience what Americans go through on a daily basis.

My thinking is if Obama wins, then we will see quantitative easing continue. And with the recent positive economic numbers on Friday it should give some confidence to investors that things are slowly stabilizing (which is bullish for stocks). But, if Romney wins, then we could see Quantitative Easing cut or eliminated, which is obviously bad for equities.

So, let’s just jump into the charts that show what I feel will unfold in the next few days and months.

Using the season chart of the four-year election cycle we can see what the Dow Jones Index (INDEXDJX:.DJI) has done in past election periods. Obviously every market environment is drastically different in each situation but overall we see stronger stock price. This is naturally a very emotional time for investors, but once the election is finished, most individuals become more confident simply because there is a leader that has four years to make things better and the campaigning is over.

Dow Jones Industrial Average Exchange Traded Fund (NYSEARCA:DIA) Daily Chart:

Looking at the chart of Dow DIA Index fund you can see a five- to six-month cycle in the market which has a positive skew. Just so you understand what a positive skew is, I will explain.

Positive skew is when the market is trending up, making a series of higher highs and higher lows. Because there are naturally more buyers during a bull market, each cycle upswing lasts longer than the cycle downswing, so you get longer rallies. This sends your secondary indicators (stochastics, volatility, put/call ratios, advance/decline lines etc.) in the overbought levels for extended periods of time. Those trying to pick a top continually get their head handed to them. The focus must be on buying the pullbacks. Keep in mind volatility is higher which means risk per trade is higher. Overall in the long run you stand a much higher chance of making money trading with the trend than trying countertrend trades (picking a top).

So as you can see below, it looks like the stock market will be trying to put in the bottom over the next week or two, which falls in line with our election cycle. It is very important to know that some of the biggest drops take place during intermediate cycle lows. These sharp drops are needed to cleanse the market one last time and shake as many traders with tight stops out before it reverses and starts the next rally. I would like to see a one- to three-day market sell-off as that would be the signature bottoming pattern I like to buy.

Keep in mind that any index or high beta stock can be traded using this same cycle (such as Apple (NASDAQ:AAPL), SPDR S&P 500 ETF (NYSEARCA:SPY), iShares Russell 2000 Index ETF (NYSEARCA:IWM) and PowerShares QQQ Trust ETF (NASDAQ:QQQ).

Bond Prices – Moving Against the Norm

Bond investors are some of the most conservative people in the market. They do not like to take risks so they dump their money into bonds to make a tiny profit in exchange for low risk (volatility). The nature of these investors is to put more money into bonds as we enter the election because they are nervous about not knowing who will be in control of the country.

After an election is over, some money flows out of bonds and into stocks because there's now a president and direction for the country. Generally, come the new year, investors move to bonds as the safe haven as they try to figure out what their game plan will be.
So looking ahead to this week and the next two months, I would not be surprised to see bond prices rise or trade sideways while stocks move higher. This analysis is based on Obama winning. If Romney wins, then I feel bonds will rally much more and stocks could sell off.

iShares Barclays 20+ Year Treasury Bond (NYSEARCA:TLT) Daily Chart

Here is a chart of 20+ year bonds, showing a possible reversal to the upside that could trigger as soon as next week. This chart is forward-looking one to two weeks. Overall the trend remains down, but if Romney wins I feel bonds will break out above the red resistance levels and trigger a new uptrend. 

Election Year Trading Cycle Conclusion

Next week is going to be very interesting to watch unfold. I generally do not like to trade or invest before news of this magnitude, so trade smaller sizes if you choose to as price action could be wild.

Editor's Note: Chris Vermeulen offers more content at his sites, and Traders Video Playbook.
No positions in stocks mentioned.

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