North American equity markets historically have been a challenge during U.S. mid-term election years. 2014 will be no exception. On average, the Dow Jones industrial average has recorded a significant gain by the end of a mid-term election year. However, it also recorded a significant correction during the year. Mind the gap!
What usually happens to U.S. equity indices during a mid-term election year such as 2014? Data for the past 81 years for the Dow Jones industrial average shows that the index normally follows its regular seasonal pattern early in the year with a slight correction in January followed by a significant upside recovery into late April. Thereafter, the index diverges from its four-year presidential election cycle: A peak in late April is followed by a correction averaging 5 per cent lasting until the beginning of October. Thereafter, U.S. equity markets return to their regular seasonal pattern by moving significantly higher by the end of the year.
Why the mid-year swoon during a mid-term election year? Politicians and their actions (or lack of actions) have a significant impact on equity markets during this period. The U.S. election season ramps up in May and escalates until the end of September. During this period, economic and market uncertainty escalates, particularly in years when negative advertising is a focus. After the mid-term election is held on the first Tuesday in November, uncertainties are relieved and equity markets resume their upside momentum.
What about 2014? American voters are highly polarized. Negative rhetoric through the media is expected to reach an all-time high this summer. The biggest battle is for control of the Senate: More Democrats currently control seats available for re-election than Republicans. A small shift in voter sentiment could have a significant impact on the future direction taken by Congress and the President. Shifting voter sentiment creates economic and investor uncertainty.
Preferred strategy in 2014 is to look for better equity investment opportunities other than the U.S. equity market, particularly during the late April to end of September period. The Canadian equity market offers that opportunity. Strange, given performance of the S&P/TSX composite index relative to the S&P 500 index during the past three years! Since October 2010, the S&P/TSX composite has gained 8.0 per cent. However, the S&P 500 index has vastly outperformed the S&P/TSX composite during the period by gaining 26.0 per cent.
The main reason for relative lack of performance by the composite has been declining commodity prices. Since October 2010, the CRB index, that measures a broad range of commodity prices, has declined 14.5 per cent. However, for the first time in three years, the CRB index is showing technical signs of recovery, a scenario that favours the Canadian equity market. World demand for commodities finally is increasing. Prices of commodities such as copper, nickel, zinc, crude oil and natural gas are recovering from oversold levels.
Seasonal influences for the S&P/TSX composite index relative to the S&P 500 index also are factor. Other than the past three years, the composite has outperformed the S&P 500 index on average by 3.0 per cent from Dec. 10 to March 10 based on data for the past 20 periods. This year, the S&P/TSX composite relative to the S&P 500 index bottomed on Dec. 10 and is showing early signs of outperformance.
On the charts, the S&P/TSX composite index has an improving technical profile. The index resumed an intermediate uptrend on Dec. 24 on a break above 13,517 to a thirty month high. The index trades above its 20, 50 and 200 day moving averages.
Preferred equity market strategy in 2014 is to invest in one of Canada's three most actively traded exchange-traded funds that track the S&P/TSX 60 index or the S&P/TSX composite index. The three ETFs are iShares CDN S&P/TSX 60 Index Fund (XIU), Horizons S&P/TSX 60 Index ETF (HXT) and BMO S&P/TSX Capped Index Fund (ZCN).
Don and Jon Vialoux are the authors of free daily reports on equity markets, sectors, commodities and Exchange Traded Funds. They are also research analysts at Horizons Investment Management, offering research for the Horizons Seasonal Rotation ETF (HAC-T). All of the views expressed herein are their personal views, although they may be reflected in positions or transactions in the various funds managed by Horizons Investment. Horizons Investment is the investment manager for the Horizons family of ETFs. Daily reports are available at http://TimingTheMarket.ca/ and http://EquityClock.com.