Convention(al) Thinking

Bottom Line: The Dow has shown quite positive performance after opposing parties’ political conventions, though it is questionable that the conventions have much to do with it.

An important part of trading and investing is not only trying to find out what works, but also figuring out what doesn’t work. Statistics get passed from one trader to another, maybe even making it to a few reputable news organizations, and before you know it another nugget of market “wisdom” is passed along.

While I hadn’t heard this one before, my friend and excellent market strategist Tony Dwyer of FTN Midwest Research suggested we take a look at past political conventions and their effect on the market. Specifically, how the market acted around the convention of the opposing party to the sitting Presidential incumbent. The theory is that the opposing party’s momentum peaks around convention time, which also likely coincides with the peak in uncertainty regarding the election outcome. Once the crowning moment of the campaign is past, the uncertainty lifts a bit and the market is free to rally once again. While the theory may have some merit, and the figures could be construed as backing it up, whether the conventions have any impact at all is questionable.

The table below details how the Dow Jones Industrial Average performed surrounding each of the opposing party’s conventions since 1904.

100 Years of Political Conventions Opposing Party Only DJIA, 1904 - 2004
	30 Days Prior	10 Days Later	30 Days Later	60 Days Later	90 Days Later	120 Days Later
07/06/04	3.8%	4.8%	6.1%	14.2%	24.5%	44.5%
07/07/08	1.3%	4.6%	12.8%	5.6%	10.7%	17.1%
06/25/12	-0.1%	-0.8%	-0.2%	1.5%	3.1%	0.2%
06/07/16	4.7%	-2.0%	-5.9%	0.3%	9.7%	14.1%
06/08/20	-3.1%	0.5%	-1.3%	-6.7%	-5.6%	-6.5%
06/24/24	5.4%	4.1%	8.6%	10.4%	10.2%	16.7%
06/26/28	-2.7%	3.8%	5.2%	16.0%	20.2%	34.6%
06/27/32	-15.6%	0.1%	35.6%	80.5%	48.7%	49.4%
06/09/36	2.1%	2.8%	6.8%	8.6%	10.6%	15.9%
06/24/40	8.4%	-1.8%	1.9%	6.8%	5.5%	8.9%
06/26/44	5.9%	1.3%	-1.2%	-3.2%	0.0%	-0.8%
06/21/48	2.6%	0.4%	-4.6%	-4.8%	0.3%	-8.7%
07/07/52	3.8%	0.3%	0.8%	-1.3%	-0.3%	6.5%
08/13/56	3.8%	-1.7%	-6.5%	-4.5%	-4.7%	-8.6%
07/11/60	2.4%	-6.1%	-1.5%	-10.5%	-5.6%	-3.8%
07/13/64	3.9%	-0.5%	-1.0%	3.5%	5.5%	2.9%
08/05/68	-4.5%	1.8%	7.0%	10.4%	5.6%	5.1%
07/10/72	-4.0%	0.3%	3.7%	2.4%	7.1%	10.7%
07/12/76	3.9%	-1.9%	-3.9%	-4.4%	-7.2%	-0.6%
07/14/80	7.3%	2.2%	5.6%	6.1%	9.4%	9.6%
07/16/84	-0.7%	-0.6%	9.9%	5.2%	7.0%	6.1%
07/18/88	3.1%	0.6%	-3.6%	1.8%	-1.9%	3.6%
07/13/92	-1.7%	-1.7%	-3.3%	-4.8%	-4.3%	-1.1%
08/09/96	-0.8%	0.7%	3.8%	6.3%	11.0%	20.1%
07/28/00	-0.4%	4.9%	6.5%	-2.3%	3.7%	0.7%

Avg Return	1.1%	0.6%	3.3%	5.5%	6.5%	9.5%
% Positive	60%	64%	56%	64%	68%	72%

During the past three election cycles, the Dow showed a negative return in the 30 days leading up to the conventions, which bucked the overall, long-term trend. Most of the time, the market was positive heading into the event.

In terms of the percentage of time the Dow was positive after the conventions had passed, there is nothing particularly remarkable about the results when compared to any other average period. However, in terms of average return, these periods do appear to be significantly more positive than average. 90 days after the convention, which would roughly coincide with the election, the Dow was an average of 6.5% higher than when the convention began (with 17 out of the 25 occurrences being positive). That is about triple what an average 90-day period showed during the study period. The average gain was about triple the average loss as well, telling us that those instances that were negative tended to be far outweighed by the positive.

I showed in February that the second half of election years tends to be quite positive, and similar stats have been gaining in number in the popular media recently. While election year seasonality is statistically impure (due to the difficulty in proving that it is significantly different than what could have occurred by chance), it is widely accepted and could become a self-fulfilling prophecy simply because so many people know about it and believe in it. The period from about now until the fall has a tendency to be particularly positive during these years, and while I don’t think it has much, if anything, to do with the political conventions, it is an intriguing reason for the potential downside to be limited.

Bottom Line: Over the past 20 years, the correlation between crude oil prices and the stock market has been negligible. On a smaller time frame, however, there is a relatively minor negative correlation, suggesting recent spikes may be a bit negative for equities.

Often, when something is written about daily in the financial news, I get a fair number of questions from subscribers about the topic. More often than not, the deluge of questions tends to coincide fairly well with a turning point in the market.

The “hot” topic now is oil, as it is fretted about in each news broadcast and newspaper edition. I’m certainly no expert on the topic, and it’s somewhat out of the normal realm that we discuss here, but since I have received so many questions, I thought I would address it. However, a major caveat is that whenever we look at past instances in regards to economic forces, it’s difficult to extrapolate those results into the future. Traders are constantly re-assessing whether “good” economic news is actually “bad” and vice-versa. I’m not quite sure how extremely high oil prices could be construed as good news, but then again I’m no economist.

To get some perspective, first let’s look at a 20-year chart of oil (light, sweet crude futures contracts traded on Nymex) versus the S&P 500:

There’s not much of a correlation here. Obviously, during this time the S&P was in a major bull market, and we don’t see the volatility of the 1970’s. While there is little long-term correlation between the two markets, on a short-term basis there is something of a negative one. The correlation between the 30-day change in oil and future 30-day change in the S&P 500 has been -0.13 (on a scale of -1 to +1). So that means that whenever oil rallied over the prior 30 days, the S&P tended to decline over the next 30 days. This is one of the highest correlations between the data, positive or negative, across many different time frames.

Looking at the data another way, whenever crude oil hit a new 52-week high, the S&P performed almost exactly in line with the average performance over the study period – it was no more or less positive than usual. On the other hand, when oil hit a new 52-week low, the S&P performed significantly better than average, with short-term returns that were about double the norm, and the market being positive a significantly higher-than-average percentage of the time. The conclusion from that could be that low oil prices tended to be a bullish factor for the market, but high oil prices were not necessarily bearish.

Let’s look at how the S&P performed after oil formed its major peaks over the past 20 years:

S&P Performance After Major Oil Peaks 1983 - 2004
Peak Date	Price of Oil	5 Days Later	10 Days Later	30 Days Later	60 Days Later	90 Days Later	120 Days Later	250 Days Later
11/20/85	31.72	1.8%	2.0%	4.5%	11.7%	14.9%	23.0%	24.4%
10/11/90	40.42	3.5%	5.0%	6.6%	5.4%	23.5%	29.0%	29.1%
01/09/97	26.37	2.0%	3.0%	6.2%	1.0%	10.4%	21.1%	22.9%
10/13/00	34.99	1.7%	0.4%	-2.8%	-3.4%	-7.8%	-9.9%	-20.7%
03/12/03	37.83	8.7%	8.2%	13.3%	22.8%	21.7%	25.7%	38.1%

Average Return		3.5%	3.7%	5.6%	7.5%	12.6%	17.8%	18.8%

Up to 10 days after oil formed its major peaks, the S&P was positive every time with an average gain of nearly 4%. After that, there was one negative instance out of the 5 observed. Mostly, the returns were extraordinarily positive, though again this was during the greatest bull market in history.

It is extremely difficult to apply past market reactions to these sorts of forces to our current situation, but from this data at least, it is apparent that when oil peaked at a very high level, it did not have an adverse impact on the market. Of course, those peaks can only be identified in hindsight, and so far we are seeing no signs that oil has formed one now.

Last time I noted that our shortest-term measures were back to overbought, and a decline towards Monday’s lows could set up a decent buying opportunity. We ended up getting such a thing, so we increased our equity exposure a bit in the model portfolio on Tuesday morning. Now we’re back to a somewhat similar situation, in that we are short-term overbought within a larger downtrend.

I’ve noted in the last couple of comments that the market has felt “washed-out”, and it still feels that way. Traders have been rushing back to ETF’s lately, with both SPY and QQQ seeing increased interest. Our SPY Liquidity Premium, a measure of how much traders are favoring the ETF over the actual components of the index, has increased substantially this week and is near where it was in May (click here to view the chart). And according to just-released figures from AMG Data, investors pulled more money out of equity mutual funds over the past week than they put in. This is the second time in three weeks we have seen fund outflows, which is the first time we have seen such an occurrence since mid-May (and May 2003 prior to that).

We’re at a more difficult juncture now than at any point in the past few months. As noted above, there are signs that the market is washed out, yet there are others that we’re nowhere near the levels of pessimism seen earlier this year. We never get 100% agreement from our measures, but at major turning points more of them are pointing the same direction than we have now. I think the downside risk is probably limited at this point, at least for the next few weeks, and I will be approaching any further declines as opportunities to possibly add to long positions. However, should the S&P break and hold below 1075, we could see a spike in selling as obvious support is broken. That should set up a better longer-term situation for longs, but we’ll cross that bridge if we come to it.