Why the Market Bears Are Roaring

When events transpire to make our government appear less secure, foreign investors get nervous. They don't necessarily withdraw funds. They just send less, which has the effect of making a rising market pause.

So what is the issue now? It's not just that the Bush administration is suffering from the weakest polling numbers in recent years. It is that foreign and other sophisticated investors smell the potential for major changes following the midterm elections, including the possibility of a Democrat takeover of Congress and the potential for tax-law changes and impeachment hearings.

Although a strong market always climbs a wall of worry, history has shown that investors do not like the impeachment process one bit. The dreadful bear-market years of 1973 to 1974 are the classic example. Yet you really only need to look back to 1998 and 1999 at the President Clinton impeachment process. The market ultimately rallied big in both of those years, but there were several death-defying 10% slides along the way.

There should be little doubt that if the Democrats' message finds a receptive ear among the public, Mr. P says, there will be investor-paralyzing hearings well into 2007. This is particularly true if, as rumored over the past week, key presidential aide Karl Rove is indicted for his role in the Valerie Plame affair. It's therefore a good time to get cautious on most industrials and consumer cyclicals. He sees the potential for a slide of as much as 20% over the next nine months.

Dangerous Time for Market

Of course, from a cyclical point of view, this makes sense. The midterm election year of a second-term president tends to be one of the most dangerous for the market. And this year, the ugliness may be amplified because of President Bush's low poll results. According to Ned Davis Research data, since 1950, the market has lost 3.5% during the period from April 30 to Sept. 30 during midterm election years vs. a gain of 0.9% in the period in all years and a gain of 5.6% in the other half of the year -- Sept. 30 to April 30. In other words, we are now entering what is historically just a bad, bad time for stocks.