Cause and Effect in U.S. Mid-term Elections?

One of the most interesting findings mentioned in the Paul Desmond Q&A referenced in the last post was this:

"Investors simply have to go back through history and realize there is a very consistent pattern of market bottoms about every four years. You can go back and see, for example, there was a major bottom in '49, '53, '57, '62, '66, '70, '74, '78, '82, '87...Then '90, '94, '98, 2002 and that would lead us four years later to another major bottom in 2006."

I noticed that these years (after '57 and excepting '87) all landed on the year of U.S. mid-term elections. The conventional wisdom on mid-term elections has been that they have favored the party out-of-power. Desmond also notes in the interview:

"...historically, more bottoms occur in the September-October period than at any other time."

Hmm...a major market bottom directly preceding mid-term elections in which the party in power usually loses ground. Is there a cause and effect relationship here? You know that we'll be hearing about this incessantly as the election nears and the stock market tanks, with every possible spin from media outlets, politicians, and market analysts. So many experts, so many conflicting opinions. Who to believe?

Take the clueless approach! Disregard what the experts say they "know" for a minute and look at what the data says. [Note: I'm stipulating for the sake of analysis that Paul Desmond's assertions are accurate. I don't have the money to recreate the data independently. If you have facts contradictory to his findings, stop reading now and leave a pointed comment!] According to Desmond, the pattern that leads to market tops is that investors put in all the money they have to invest long before a top is reached.

"The major emotion that's present at a top is one of complacency, where people are fully invested in stocks, or are invested as far as they are going to get, but they are convinced that prices are going to keep going forever, and therefore they are willing to ignore the initial market declines that come along from time to time. As they say, they are 'in for the long term.'

At market bottoms, you have a completely different pattern in which the dominate emotion is fear and panic. And what we found at market bottoms, for example, was that in a typical major market bottom, you see a series of 90% downside days, 90% of all the volume, 90% of all the price changes are on the downside."

The recurring pattern over 50+ years is one in which buying continues until there's no more money, followed by people sitting on crossed fingers, followed by increased selling pressure, followed by raw panic selling until all the panickers have sold. But is the cycle driven by the elections?

Because the '49, '53, and '57 crashes occurred more than a year before the election, the data wouldn't seem to suggest a direct correlation. In fact, in '50, '54, and '58 stocks would have been a year into recovery by the election, but the 1958 election was one of the worst for the party in power during the latter half of the 20th century. Conversely, the market bottoms showed up right on time in '98 and '02, yet the party in power gained seats in each of those elections. My vote: no cause-effect relationship of mid-term election results on the stock market.

What about the other direction? Is there a cause-effect relationship between stock market bottoms and mid-term election results? And if you say 'yes', be prepared to explain the results of '87 (stocks flying high prior to the '86 election), '98 and '02. I think there are enough exceptions to rule out a strong cause-effect relationship. Influence due to general voter sentiment, yes, but the 2002 results in particular show that other factors can have equal or stronger influence on mid-term elections.

So as the cacophany of "expert analysis" rises between now and November 7th, give it the "clueless" scrutiny it deserves before believing any of it. If nothing else, it will turn some of the annoyance factor into amusement!

Note: source for election results is available in post title link