The market signs to watch during the presidential cycle

The old Wall Street chestnuts aren't working ... or are they? Several traders have inquired why the old Wall Street chestnuts don't seem to be working any more:

1. As goes January so goes the year — but the is up 7 percent so far this year!
2. Sell in May and go away — but the S&P is up 5.8 percent since the end of April!
3. August is the weakest month of the year — the S&P is up fractionally, though it's still early.

Have we entered some weird new universe? Is the Fed causing these signals to fail? (That's what a lot of traders think.)

Relax. It may be as simple as realizing that there are other signals that are equally important.

I consulted my old friend Jeffrey Hirsch of the Stock Trader's Almanac about the failure of these signals. He pointed out that history indicates that presidential election years can have an outsized influence on the market, and that when you layer in the presidential election signals, the markets are behaving in a fairly predictable manner:

1. Markets tend to do better when the incumbent party appears to be winning, and for the moment Hillary Clinton is ahead in the polls
2. The last seven months of election years tend to be strong, with just two losing streaks (out of 16 elections) since 1952.
3. What about August is the weakest month? While August has been the worst month for the Dow and the S&P 500 and the second-worst for the Nasdaq since 1987, it's just the opposite in presidential election years: It's #4 for the S&P 500, #5 for the Dow, and #1 for the Nasdaq. This may have to do with a post-convention bounce.
4. What about sell in May and go away? Hirsch notes that this signal has become significantly more refined. Simply put, the rule is: Don't sell in May in the third and fourth year of the presidential election cycle.

How did he come to this conclusion? By combining the historical data for seasonal stock market patterns (sell in May, buy in November) with the four-year presidential cycle (first two years tend to be underperform, last two tend to outperform) then throwing in a seasonal buy and sell signal, you get the best returns.

This is what the recommendations look like:

Source: Stock Trader's Almanac

Tricky, eh? But Hirsch insists that the effects of a presidential election cycle are so profound that they have to be incorporated with the old chestnuts.

Oh, and what about, as goes January, so goes the year? Hirsch noted that the proper interpretation of this rule is that every down January on the S&P 500 since 1950, without exception, preceded either: 1) a new or extended bear market, 2) a flat market, or 3) a 10 percent correction.

Hirsch says that the January barometer did work with the correction that followed in January and February.