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Figure 10 – This chart, inspired by Joe Ellis’ book Ahead of the Curve, shows real average hourly earnings after correcting for inflation, bear markets (grey boxes) and earnings peaks (red arrows). The brown dashed line is the linear regression trend line. Note the number of times that red arrows presage bear markets.

Where We Are in the Election Cycle
The most powerful short-term cycle operating in markets is the four-year election cycle in the United States. Between 1913 and 2005, the Dow Jones Industrial Average has dropped an average 22.2% from its post-election high to mid-term year low in September of the second year of a mandate, according to The Almanac Investor. This means that the next few months will be a challenge to markets if history is any guide.

But the good news is that, thanks to a government habit of kicking the printing presses into high speed and doing everything it can to promote economic prosperity heading into elections, the Dow has gained an average 50% over the two-year period from the mid-term low to election year high. There have been no losing pre-election years in the Dow Industrial Average since 1939, according to the Almanac.

View from 30,000 Feet…
The recent canary correction revealed growing chinks in the armor of global markets and economy. An unwinding of the carry trade strained a number of smaller and emerging market economies. What was more amazing was the speed and severity of the drop as more than $6 trillion dollars evaporated globally in the space of just 24 trading days impacting all asset classes (stocks, bonds, commodities and currencies) together. This is unusual. The big question remains, is it over or just the beginning?

Add to the mix unprecedented international investor complacency as evidenced by the record low value in the Emerging Market Bond Index, re-inversion of the yield curve, rapid real estate price escalation, reliance on mortgage equity to fund consumer spending, surge in mortgage and overall debt, anemic growth in real wages, big drops in homebuilding stocks and you have the makings for a potential bear market in the U.S. and around the world.

On the positive side, we are heading into a cyclical low in September-October, thanks to the election cycle. Once the smoke has settled, the market could see a healthy lift for the next 12 to 24 months. However, given the other challenges, this may only be a temporary reprieve in a downtrend that has the potential to last into the next decade.