The Little Book of Stock Market Cycles

“There is no magic formula to make trading or investing easy,” starts Jeffrey Hirsch in The Little Book of Stock Market Cycles.  “Nothing can replace research, experience, and a healthy dose of luck.”

History, however, can be a useful guide in understanding the environment in which you are investing.  This is the focus of Mr. Hirsch’s latest installment in the Little Books series.  Hirsch is the Editor in Chief of the Stock Trader’s Almanac and an authority on stock market cycles and seasonal patterns.

Cycle research is dismissed in some investing circles as “voodoo,” but Hirsch makes a compelling defense of the discipline throughout the book and explains it with clarity:  “Recurring events such as the presidential election every four years, end-of-quarter portfolio rebalancing, options and futures expirations, tax deadlines, and holidays have a predictable influence on traders and investors.”

Indeed, all of these predictable events affect flows into and out of the stock market, as do many, many others detailed by Hirsch.

Hirsch starts his book with a description of secular bull and bear markets.  For the uninitiated in market terminology, “secular” means long-term in this case.  Secular markets tend to last 8 to 20 years, and recent history has been no exception.  The last secular bull market lasted 18 years, from 1982 to 2000.  The secular bear that followed started in 2000 and still persists 12 years later.

Within a secular bull or bear market, there are smaller and shorter cyclical bull and bear markets that can last anywhere from a couple months to several years.

It is somewhat controversial to consider the 2003-2007 bull market—which peaked with a new all-time high—as a “cyclical” bull market, but I consider that a fair description given that price / earnings multiples contracted throughout the period and that it ending with one of the worst cyclical bear markets in history in 2008.  This was also the view of John Mauldin, whose Little Book of Bull’s Eye Investing we covered in a separate book review.

Though most of Hirsch’s work is empirically sound, he falls into the mental trap of confirmation bias on a few occasions and tries to fit the data to his thesis rather than shape his thesis around the data.  This was certainly the case when he contends that “a new secular bull will not emerge and lasting prosperity will not take charge until there is an extended period of relative peace.”

Why? Because “the single most important enduring influence on the stock market is war.”

Hirsch states that the stock market has never made significant headway when the United States was involved in a major war.  The problem with this argument is that there have only been a small handful of wars in modern U.S. history and certainly not enough to reasonably draw conclusions.

But more than that, the statement is just flat-out not true, at least not unless you ignore the Korean War (perhaps it was called the “Forgotten War” for a reason).  Stocks soared throughout the Korean War, as the 1950s were one of the best decades in market history.

That Kirsch considers the Iraq and Afghanistan campaigns “major wars” and Korea—where U.S. involvement lasted longer than World War I and where 36,500 Americans died—not, is a fatal flaw in his argument on the role of wars on the stock market.

The war argument notwithstanding, I would agree with Kirsch when he asserts that “all of the previous secular bull trends were accompanied by a major paradigm shift from an enabling technology or cultural change.”

Disruptive technologies are essential to the process of creative destruction that is so important in driving the economy forward.  Kirsch believe that the next boom will be driven by alternative energy (as is already happening in the shale gas boom), biotechnology or perhaps some other “yet-to-be-discovered” field.

Kirsch sees the next secular bull market—which he believes will send the market 500 percent higher before it is finished—starting in 2017-2018.

Much of the book is a description of shorter-term market cycles and seasonal patterns.  Most readers will be familiar with the Presidential Cycle, but Kirsch takes the analysis several layers deeper, looking at month-by-month returns and dividing his analysis between elections with incumbents and elections without.  Even seasoned market technicians will find some new angles on this old standard.

Kirsch takes the “sell in May and go away” maxim several layers deeper as well.   Given the time of year, it is worth mentioning that November, December, and January are the three best consecutive months out of the year:  “If you were only to be invested for three months out of the year, these are the months.”

But if this period fails to deliver, watch out.  There are macro forces at work overpowering the cyclical forces, and it is a major red flag.

Kirsch also has a trading tip that might be a bit puzzling to non-Jewish “goy” investors: “Sell Rosh Hashanah, Buy Yom Kippur, Sell Passover.”

This is really just a slight variation to the standard seasonal advice of being invested from late October to April, as Yom Kippur falls in October and Passover falls in March or April.  But as Kirsch elaborates, “Perhaps it is Talmudic wisdom, but selling stocks before the eight-day span of the High Holidays [of Rosh Hashanah and Yom Kippur] has avoided many declines, especially during uncertain times like 2008.”

In any event, The Little Book of Stock Market Cycles is a nice primer on cycle research and an excellent starting point for further research.  Kirsch is not offering a magic solution that is “guaranteed” to improve your investment performance, and he would never claim to.  But he has given us an insightful collection of market observations and plenty of food for thought.  I recommend you add it to your winter reading list.

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