The Business Cycle and Sector Rotation

By on April 18, 2011

Studies of stock market history have shown a strong tendency for the market to follow a four year pattern of expansion and contraction.  This phenomenon has been linked to a strong correlation with the presidential election cycle.  Typically about two thirds of the time (2.5 years or so) the economy is expanding, followed by a year and a half of contraction (or bear market phase).

We appear to be approaching the peak of this cycle (within 6 months or so of) as energy has been strong over the past few months.  Defensive stocks such as Unilever PLC (UL), Kraft (KFT) and Conagra (CAG) demonstrated unmistakable relative strength last week.  This shift in leadership has typically presaged a fall in the equity market.

However, the four year cycle is not etched in stone.  It can be off by many months.  The previous bull market lasted around 5 years; much longer than usual.  This was likely due to the extraordinarily low interest rates engineered by Alan Greenspan and the massive bubble in housing and home equity withdrawal unnaturally juicing the economy.

Interest rates are currently the wild card.  Employment is still extremely weak.  This could throw this cycle off somewhat as wage inflation pressures remain anemic.  It is difficult to determine how this will play out.  The average presidential cycle calls for strong gains this year with a still positive, but somewhat more subdued market next year. 

The stock market, as always, remains an unpredictable mistress.

Click on image for larger version:

sector rotation model

The Standard Business Cycle

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