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


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).

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No positions in stocks mentioned.

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