Ready to Rally Into Year-End

 | Nov 01, 2011 | 9:45 AM EDT
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I'm a big fan of the fourth-quarter effect in global stock markets, and I'm an even bigger fan of the six months from Nov. 1 through the beginning of May. This is the time of the trading year when I really put the pedal to the metal in my trading services and managed accounts.

While you might rightly view such blind faith as the equivalent of carrying a rabbit's foot for good luck, it's a rule of thumb that has proven to be one of the single best predictors of global financial markets during my investment career.

I must concede, though, that the market's action in August and September tested my blind faith considerably. But I now believe 2011 will end on a very strong note. And here's why.

First, we are in the midst of one the most powerful rallies in recent financial memory. As of Friday's close, the S&P 500 was up 16.7% from its Oct. 4 lows. The MSCI Emerging Markets index soared 23.4%. These would be impressive gains over the course of an entire year, let alone a single month. Although my faith was shaken, the traditional fourth-quarter rally started right on cue. I just didn't know it at the time.

Second, 2011 is the fourth quarter in the third year of the presidential election cycle. And historically, that makes it a particularly strong one. Between 1948 and 2008, in the third year of a presidential election cycle, the S&P 500 has risen by an average of 22.34%. But things were looking pretty shaky only a month ago. After all, for most of the year, the S&P 500 was showing a negative return. And 2011 saw the worst drawdown ever in the third year in a presidential term, with the S&P 500 declining 14.5% from the last trading day in 2010. That all changed with the impressive October rally. The S&P 500 is now up 2.18% for the year, as of Friday's close.

Notwithstanding its recent strong gains, the S&P 500 would have to rally to 1555 over the next three months -- up 21% from its current levels -- to match its average return of 22.34% for the third year of a presidential cycle. That kind of gain is unlikely to happen between now and Dec. 31.

Nevertheless, let's drill down even further to look at the performance of the S&P 500 in the fourth quarter of year three of the presidential election cycle. As points out, since 1950, the fourth quarter of the third year of the presidential cycle has been positive 13 out of 15 times. Its worst performance was during the last presidential election cycle -- the fourth quarter of 2007, when the market fell a mere 2.5%. Over time, however, the average gain in the fourth quarter was over 5%.

After the rip-roaring performance of the U.S. market over the past month, odds are darn good that the S&P 500 will end the fourth quarter at a higher level than where it started. And with the strongest six months in the markets just beginning, I think it's still got a ways to go. And it's a trend I'll be looking to play with a leveraged bet on the S&P 500 through the ProShares Ultra S&P 500 (SSO) -- but only after we get some consolidation of the S&P 500's recent gains.

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