If you have followed my U.S. stock market analysis through the years, you would know I have, correctly, been steadfastly bullish. In fact, I was one of the few who expected equities to rocket higher after Donald Trump won the election in November.
And now we are approaching the 2,500-point target in the S&P 500 Index SPX, -0.11% that we had expected to hit. However, just because the market has rallied strongly after the election does not mean we expect it to continue into the next election season of 2018. Let me explain why that is so important.
“It’s the economy, stupid”
James Carville, one of President Clinton’s campaign strategists, coined a term years ago that has been considered the most important factor for an incumbent president being able to win re-election: “It’s the economy, stupid.”
But, based on a 2012 paper written by Prechter, Goel, Parker and Lampert, which analyzed presidential elections from 1789-2008, they determined that factors such as gross domestic product, unemployment, inflation and so on are not significant predictors of the outcome of an incumbent’s re-election bid. Rather, it is the direction of the stock market in the one to three years before the re-election bid, which is the best predictor of success for the incumbent. Here they write:
“Generally, incumbents who preside over a net advance in the stock market tend to obtain a higher vote margin than incumbents who preside over a net decline in the stock market in the one, two, three and four years before the election. Of all the variations we test, the relationship between the three-year net percentage change in the DJIA and the incumbent’s popular vote margin is the strongest and achieves the highest level of significance.”
So rather than it being the economy, it is probably more accurate to adjust Carville’s perspective to: “It’s the stock market, stupid.”
Now that history has shown us the best predictor for an incumbent to win re-election, let’s review our expectations for the stock market to see if we can glean something from the expected timing of the stock market’s movement relative to the next presidential election cycle.
As I noted at the end of 2015 and early 2016, I expected the market to set up a strong rally from the 1,800 region in the S&P 500 toward a long-term target in the 2,537-2,611 area. And we are now finally approaching that target, as the market has been adhering well to the sentiment patterns we have been tracking for years. However, just because we are approaching the bottom of that target region does not mean that I expect the market to top out for years to come.
While I am expecting the market to strike a top within the next several weeks, I believe it will only provide us with a short-term pullback, likely into the fall of 2017. I still believe we have more to see in this bull market going into 2018.
However, once we move into 2018, this is where it is going to get tricky. You see, I believe we will likely strike a significant market top in 2018, and that will likely occur no matter what is going on in the political arena. My expectation is that such a market top will likely usher in a 15% to 20% correction in the stock market.
The question will then be: How long will this correction last? Within the Elliott Wave construct, we have a rule of alternation that suggests that when a 2nd wave of a certain degree is a sharp and fast correction, you should expect the 4th wave to be a slow, grinding type of correction. Since the 2nd wave of our structure from the 2009 lows was only a three-month event, it is certainly possible that the 4th wave may morph into a triangle pattern, which can take a year or two. Being mired in a sideways stock market grind is not what an incumbent president is going to want to see to help his re-election bid.
However, as you can see in my attached chart, if the market is able to maintain the trend channel we have created since the 2009 bottom, it would seem we can still complete the 4th wave correction by the end of 2019, even if it does develop as a triangle.
The key question
Now that I have likely bored you with the technical work that I do, let’s get to the meat of the issue. It is becoming likely that the market is going to revisit the region from which we began to rally at the time of the 2016 election and it seems likely we will strike that region by 2019. So, this “should” leave us enough time for the market to be able to rally for a year into the 2020 election. Based on historical evidence, as identified by Prechter, et al., it would suggest that Trump should win his re-election bid for a second term.
But the question his communications team would want to consider today is whether they want to take ownership of the stock market action when it is looking likely that equities will experience a sizable correction beginning next year (based on the patterns the market has been following for years). From this analyst’s perspective, it may be best to wait until 2020 before the president wants to ride the coat tails of the stock market.
See charts illustrating the wave counts on the S&P 500.
The writer has no holdings in any securities mentioned.
Avi Gilburt is a widely followed Elliott Wave technical analyst and author of ElliottWaveTrader.net, a live trading room featuring intraday market analysis on U.S. indices, stocks, precious metals, energy, foreign exchange and more, along with an interactive member-analyst forum and detailed library of Elliott Wave education.