Debt Views

One of the keys to successful trading and investing is to understand how market cycles operate in a variety of time frames and to profit accordingly. Sadly this is easier said than done as the majority of traders and investors are either mesmerized or alarmed by the hourly and daily moves of the stock markets. Back in 1903 S A Nelson, a good friend of Charles Dow, wrote: “Many people seem to think that the change in prices in any one day is complete in itself and bears no relation to larger movements which may be under way. This is not so.”

There have been many books written about Dow Theory and I do not propose to re-evaluate it in this article, rather I am suggesting that newbie traders and investors should be aware of the effect of one such cycle – the four year US presidential cycle which has now well and truly started.

The theory behind this cycle is that as the election draws near, the administration will do everything in its power to stimulate the economy so that voters will go to the polls with jobs and a feeling of economic well being. Interest rates are generally lower in the year of an election so the stock market can benefit from increased spending. Presidents know that if voters are not happy with the economy when they go to the polls, the chances of re-election are slim.

A combination of the presidential cycle and the lengths to which the current administration is prepared to go to avoid a recession and meltdown in the financial system are the main reasons why I believe the US stock market could actually do quite well in 2008. President Bush convened the so-called Plunge Protection Team last Friday for its first known meeting since 9/11. Officially the President’s Working Group on Financial markets was created after the 1987 crash and appears to have powers to support the markets in a crisis with a raft of instruments, mostly by buying futures contracts on the stock markets (DOW, S&P 500, NASDAQ and Russell) and it has the means to destroy short traders.

Ironically the team is led by Henry Paulson, ex Goldman Sachs, whose old employers were one of the few investment banks to have made a profit from the sub prime debacle last year. A pity Henry failed to spot the dangers from either these toxic investments or the subsequent credit crunch. His brief is now to investigate the “systemic risk posed by hedge funds and derivatives” and based on his experience with Goldman Sachs it will be interesting to have his views in the coming months.