Remember these words: the stock market hates uncertainty. More than anything else, the market just absolutely hates uncertainty. I have seen the stock market rally in the face of good news – no surprise there. A better-than-expected inflation number, lower unemployment, a cut in interest rates by the Fed, etc… each of these events has in the past prompted the stock market to move to higher ground. Sometimes the move is just “reactionary” and other times it is sustained as part of a bigger trend. But the bottom line is that the stock market loves good news because it makes people feel comfortable investing money. And money is what moves the market. Remember those words too.

Interestingly, I have also seen the stock market also rally in the face of “bad” news. While this is counterintuitive, it makes a good deal of sense once you understand human nature. Any number that regularly gets “predicted” is a good candidate for this type of event. If the experts predict that the CPI will show an annualized increase of 3.3% and the number comes out at 3.1%, the stock market may rally. If unemployment is expected to rise sharply this month but in fact only rises slightly, the stock market may rally on this bit of “good” news. If a major corporation is expected to post a large quarterly loss and instead reports only a small loss, that stock may rally sharply based on the “surprisingly good” news, which - if the company and the announcement is high profile enough - can in turn trigger a rally in the broader market. Only in the perverse world of human nature can this occur. “Gee whiz, this one company only lost x number of dollars in the last three months. What a great excuse to buy a bunch of stocks." I am not sure if anyone ever really has that particular thought, but the net effect is still the same.

What the market really despises, though, is uncertainty. When the outcome of a major event or trend is unknown that is when the stock market really gets skittish. And there is certainly plenty to be uncertain about during these – as we are told day in and day out by the media – “troubled” times. The investing public is presently waiting to see:

• If all the banks will go out of business due to the mortgage “crisis” (a state of affairs previously referred to as “people borrowing more than they can afford”).
• If the housing market will simply vanish (which nevertheless could be a major boon for my latest venture, “Mud Huts ‘R Us”).
• Whether crude oil will top out at $130 a barrel or $230 a barrel.
• Which of the fine presidential candidates will do the honors of jacking up taxes, imposing vast economic restrictions and generally exerting much greater government control over every aspect of our lives (Okay, I clearly needed to get that off my chest).

In most cases, predictions always run rampant despite the fact that in the vast majority of cases one cannot accurately know in advance how a particular uncertainty will play out. Also in most cases one also cannot predict when a given uncertainty will be resolved. But there are exceptions to every rule. For example, while we cannot know when and at what price crude oil will top out, one thing we do know is that between now and the end of the year a new president will be elected. And while a certain percentage of the population will not be happy with the choice, the fact remains that this does amount to the removal of a great uncertainty. Which, in turn, could be bullish for the stock market (at least until the lousy new pollicies start getting enacted).

So let’s consider the history of the stock market during “election season." Sometimes the outcome is pretty well known in advance. Other times it goes down to the wire. And nowadays, if the lawyers get involved, the uncertainty can extend beyond Election Day. So to create a fairly “all encompassing” time frame, let us look specifically at the action of the stock market between May 31^st and December 31^st of each presidential election year.

In Table 1 you see the historical performance of the Dow Jones Industrial Average during this time period.

Table 1 – Dow Performance between May 31^st and December 31^st of each Presidential Election Year

Chart 1 displays the growth of $1,000 invested in the Dow Jones Industrial Average only between May 31st and December 31^st of each election year since 1900.

Chart 1 – Growth of $1,000 invested in the Dow only between May 31^st and December 31^st of each Presidential Election Year

Chart 2 displays the performance of the Dow between May 31^st, 2004 and December 31^st, 2004. As it was a tight race, there was great uncertainty leading up to the election. That uncertainty kept a lid on the market until Election Day approached. Once Election Day passed, the market rallied strongly.

Chart 2 – Dow Jones Industrial Average between May 31^st and December 31^st, 2004

Summary

As you can see in Chart 1, while the results are by no means a “straight line," the long-term results clearly suggest a strong tendency for the stock market to move higher during the latter part of the election year. Chart 2 clearly illustrates that this period can witness any number of market gyrations before any real upside breakthrough might occur. Nevertheless, for the record, the Dow has advanced 22 times and declined only 5 times during this 7-month time period during presidential election years. The caveat to all seasonal trends of course, is that there is no guarantee that they will work “this time around." And this one is no exception.

So do the results in Table 1 and Chart 2 imply that the stock market will rise between now and the end of 2008? Not necessarily. The results do argue strongly however, that we might be wise to give the bullish case the benefit of the doubt. Chart 3 displays a clear “line in the sand” of support for the Dow at the January low of 11,634.

Chart 3 – Favorable 7-month period starts on 5/31/08; “Line in the sand” at 11,635 on the Dow

If the Dow takes out its January low then clearly “all bets are off." Unless and until that happens, however, investors might do well to fight the urge to react to the never ending gloom and doom served up in the financial news, and to hold tight.

If things ultimately work out the way they have so often in the past, the winner of the next election might just be you.

To search for previous articles written by Jay Kaeppel, please click here.

Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site

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