Alpha Power Investing Newsletter

January 14, 2010

Election Cycle Power Zone

Get ready. It's coming in October.

It's the Election Cycle Power Zone.

The Power Zone is 15-months long, beginning 30 days before the mid-term elections. This 5-quarter period has not been down since 1931 (Dow Industrials Total Return).

The average return has been 25.5% plus dividends. The average daily return since 1931 has been 7.7 times greater than the average daily gain for all other trading days. A $1,000 investment in the Dow only during the Power Zone (31% of the time) appreciated to $68,200 as of the end of 2009. A $1,000 investment in the Dow during all other trading days (69% of the time) grew to just $1,800 since 1931.

If there is any time to be invested in the stock market, this is it.

Most investors don't realize how sensitive the market is to politics. Actually, politics is one of the main drivers of intermediate (12-24 month) market moves.

A demonstration of just how sensitive investors are to the news coming out of Washington was provided by Dr. Michael Ferguson of the University of Cincinnati and Dr. Hugh Douglas Witte of the University of Missouri, in their paper "Congress and the Stock Market" (2006). In this study the researchers calculated how the Dow Industrials performed when Congress was in-session as opposed to out-of-session. The results are enlightening.

From 1900 to 2004, the out-of-session Dow grew from $1.00 to $216.10. The in-session Dow grew from $1.00 to $2.00. Money in the out-of-session Dow compounded at 5.3%, whereas the compounding rate for the in-session Dow was just 0.38%. Over the entire time period, the out-of-session Dow accounted for 94% of the cumulative stock market return despite being invested just 34% of the time.

What this study proves to me is that investors become pessimistic when politicians are active, and optimism returns when Washington is silent.

The 15-month Power Zone is simply an example of this change in mood.

The mid-term elections do two things which lift the investment mood. First, by the time the mid-term elections come around, the electorate has become disenchanted with the dominant party - the honeymoon is over. The dominant party tends to lose seats in Congress, making it more difficult to ram through controversial legislation. Investors like a do-nothing Congress better than an activist, society-altering majority. Second, politicians, being rational and self-serving, change their rhetoric and their behavior in anticipation of the next presidential election.

Winning the White House is largely about prosperity. Politicians know that the electorate votes with its pocketbook, and that their taxing and spending inclinations must take a back burner for a while. The political rhetoric now shifts to fiscal responsibility - lowering the deficit, cutting spending, lowering taxes and other investor-friendly proposals. Investors, anticipating this, become less risk-averse and more optimistic.

My favorite combination of assets during this period of political duplicity is a portfolio split evenly between the S&P 500 and the NASDAQ 100. This is a large-cap, growth, technology-leaning portfolio. Here's the performance record of this combination over the past five Election Cycle Power Zones:

Q4 1990 - Q1 1992 57.95%
Q4 1994 - Q1 1996 42.11%
Q4 1998 - Q1 2000 107.27%
Q4 2002 - Q1 2004 57.63%
Q4 2006 - Q1 2008 19.66%

Average: 56.92%
Cumulative Gain: 781.70%
Cumulative Gain S&P 500: 404.30% (1/1/89 - 12/31/08)

As you can see, a hypothetical investor employing this strategy over the past 20 years nearly doubled the return of the S&P 500 without earning interest during the intervening months. Throw in interest from conservative bonds, say Barclays 1-3 year Treasury Index, and you get a 20-year return in excess of 15% per year, about twice the annual return of the S&P 500 since 1989. Best of all, our hypothetical investor would have experienced gains every year.

Of course, no strategy is foolproof and guaranteed to win, but we can count on rising investor expectations causing a favorable investment climate after the mid-term elections. Absent any economic or political disasters, this should translate into another profitable Power Zone.

Sincerely,
Jerry Minton, Ph.D.
President


Disclosure: For a more complete examination of these issues please go to www.alphaim.net. In the Programs section of the website, the E-System material contains detailed data on this strategy and Alpha's enhancements. Past performance is not a guarantee of future performance. Data presented does not represent the performance of an Alpha program.

© 2010 Alpha Investment Management Inc.

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