|Jeremy Grantham this past weekend in Barron's on the impact of presidential cycles:|
But this one will?
A: It is the third year of a presidential cycle. The presidential cycle is enormously important. The presidential cycle for me starts in 1932. Before then, the whole idea of stimulus hadn't sunk in. Keynes explained the concept and in Franklin Delano Roosevelt he had a very interested listener.
From then on, administrations understood it is a good idea to stimulate the economy in year three, so that in year four unemployment — and this is key — is dropping. It's fine to have a strong economy, but it is unemployment that really drives the vote, our research shows. The third year in a presidential cycle is not just a bull-market year, but one with a bubbly flavor to it where growth wins. It's the only year in the cycle that growth wins. The speculative stocks outperform the quality stocks and small caps do very well.
Q: How does this third year stack up against those in the past?
A: This is a classic third year. The absolute return, minus inflation, is 17% in the third year and believe it or not that is exactly where we are, up 17%. Growth outperforms its normal relationship to value by 5% and that is exactly where it is today, to the penny. Small cap does very nicely and this time has done twice as well because it has benefited from another kicker.
While there isn't a very strong connection between the economy and the stock market, there is one very useful connection: In the 12 months, sometimes 24 depending on conditions, but always 12 following a low in the economy, small caps do very well. Low quality or junk does spectacularly.
What we found, too, is that the third year is fairly indifferent to value. Years one, two and four are reasonably sensitive to value. In year three, it doesn't matter whether the market is cheap, expensive or in between, the market goes up. In 1999, the most expensive year in American history up to that point, the market went straight through the roof, like a pea bouncing off a tank.
Q: What should we expect in year four?
A: Year four is neutral. The market comes in on average, small cap is about average, junk still wins — a little echo effect — and surprisingly value comes back and typically has the best year on average in the cycle. Value matters.
This is, of course, a glorious heaven-sent opportunity to take advantage of the rally and reposition portfolios. This is a very important rally and it will probably last through the year and may easily carry over into one or more quarters next year.
But next year is much more up for grabs. It is a very expensive market and that will be a drag. We still have very low capacity-utilization and all the problems of excess spending that went on. We have the problem of debt.