Five Inhibitors Between You and Capital Appreciation in Equities

We think there are four variables presently at work that are inhibiting stock market rise and one variable that typically means the market has gone as high as it can for the current cycle. 

The five mitigating variables are:

  1. Individual investors have gone heavily into this market; which tends to mean it is overbought.
  2. The Cyclically Adjusted Price Earnings (CAPE) ratio is sufficiently high to suggest less-than-inflation rates of return ahead on average for the next five years.
  3. Corporate profitability is going to need a significant lift from the tax changes to return the S&P 500 to a rising trend, and such a lift is not a slam dunk.
  4. The specter of a trade war is creating uncertainty.
  5. This is a mid-term election year.

We tend to readily discuss the variables one through four during our Economic Outlook Presentations and on the ITR Trends Report™ S&P 500 page. But the fifth variable tends to get overlooked. That is a mistake because it may inform our opinion about the stock market’s performance at the end of this year and in at least early 2019.

The table below shows that the S&P 500 fares relatively poorly through the first three quarters of mid-term election years as opposed to all years since 1950.



The notable exception is the fourth quarter of the year. The mid-term average is 5.0% versus the average of all years of 2.0%. A potential reason for the relatively stellar performance is because the unknown created by the election is resolved. Investors, like businesses, do not tolerate uncertainty very well.
The better-than-average performance extends through the following first quarter. Whereas the average 1Q bounce from the prior 4Q is 3.1%, there is a 7.4% 1Q bounce following the mid-terms (based on data since 1950).

  • • 3.1% = 1Q gain versus 4Q all years
  • • 7.4% = 1Q gain versus 4Q following the mid-term elections

If you see (or read in the ITR Trends Report or the ITR Insider™) that two or more of the other uncertainty variables are resolving themselves, 4Q18 or 1Q19 could turn out to be a good time to get back into the market with fervor.

Brian Beaulieu