MILLBURN, N.J. (TheStreet) -- The election of Republican Scott Brown to fill the late Ted Kennedy's U.S. Senate seat set off a political tidal wave in Washington. The Senate Democrats no longer have the 60 votes necessary to assure cloture (a vote to end debate), putting health care legislation in jeopardy and raising the stakes for upcoming midterm congressional elections, which will likely be heating up much earlier than usual.
In 2008, I wrote about how to
. With the 2010 midterm elections on our horizon, let's investigate whether we can come up with some guidelines for trading those.
Note that I have accumulated data for the
going back to 1950, a midterm election year. Thus, 2009 (a post-presidential year) represented the end of the 15th presidential election cycle in my database.
The Presidential election cycle is comprised of four distinct years:
1. Year Before Presidential Election
2. Presidential Election Year
3. Post-Presidential Election Year
4. Midterm Election Year
First, let's take a look at how each of these years and the constituent quarters has performed on average in each of the election cycle years:
Furthermore, we can look at how each of the months has performed on average by year in the election cycle:
So, armed with this data, can we trade the midterm election year? I believe we can, and here are three ways to do it.
Sell in May and Go Away
You might have heard the old maxim "Sell in May and go away." But if you look at the monthly average returns, the only historically negative months are February and September. So "Sell in May and go away" might be little more than an old wives' tale -- except when it comes to the midterm election year.
The second and third quarters of the midterm election year -- and in particular the months of May, June, August and September -- tend to be down months. Thus, it may make sense to sell or sell short the SPX at the end of April and wait until the end of September to cover your shorts.
2. Wait for the Post-Election Surge
Midterm election years tend to be more uncertain than presidential election years. During presidential election years, the focus tends to be on the presidential race, whereas while congressional races are important, they tend to be of a secondary nature to the media and electorate. Furthermore, the presidential candidate tends to have "coattails" upon which the congressional candidates will ride.
Without a presidential race in the midterm election year, the outcome of the congressional elections is less certain. Thus, the markets tend to be subdued in advance of the election and react positively after the election.
This is quite evident from the data that I have presented above. While you might want to sell in May and remain out of the market until October, once the election takes place, you might want to get aggressively get long the market at the end of September. The fourth quarter of the midterm election year and the immediately following quarter -- the first quarter of the pre-presidential election year -- are the two best quarters in the 16 presidential election cycles. These two quarters have yielded positive returns in 14 of the 15 cycles in which they have occurred. The one losing outcome was fourth-quarter 1978/first-quarter 1979, which declined only by approximately 50 basis points.
3. A Slow January, Then a Bounce
January in a midterm election year is also a losing month, January has been no exception. However, during midterm election years, February and March have been strongly positive years. So after a month of profit-taking in January, you may want to put money back to work for the next two months.
In 10 of the 15 midterm election years, the SPX has advanced during the February to March time period. Those years in which the February to March period declined in a midterm election year were: 1966 (-3.93%); 1974 (-2.68%); 1978 (-0.04%); 1982 (-7.01%); 1994 (-7.44%)
Just as a refresher, let's review how you can play the SPX. The easiest was is by utilizing exchange-traded funds. Here is a handy guide to those products:
SPDR S&P 500 : long SPX ETF
ProShares Ultra S&P 500 : ultra long 2x SPX ETF
ProShares Short S&P 500 : short SPX ETF
ProShares Ultra Short S&P 500 : ultra short 2x SPX ETF
As always, please be aware that the ultra ETFs are leveraged but are regeared on a daily basis. Thus the twice leverage is for short period of time, and long-term results may not produce the double exposure an investor might assume is being earned.
-- Written by Scott Rothbort in Millburn, N.J.
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At the time of publication, Rothbort had no positions in stocks mentioned, although positions can change at any time.
Scott Rothbort has over 25 years of experience in the financial services industry. He is the Founder and President of
, a registered investment advisor specializing in customized separate account management for high net worth individuals. In addition, he is the founder of
, an educational social networking site; and, publisher of
. Rothbort is also a Term Professor of Finance at Seton Hall University's Stillman School of Business, where he teaches courses in finance and economics. He is the Chief Market Strategist for The Stillman School of Business and the co-supervisor of the Center for Securities Trading and Analysis.
Mr. Rothbort is a regular contributor to
TheStreet.com's RealMoney Silver
website and has frequently appeared as a professional guest on
Fox Business Network
and local television. As an expert in the field of derivatives and exchange-traded funds (ETFs), he frequently speaks at industry conferences. He is an ETF advisory board member for the Information Management Network, a global organizer of institutional finance and investment conferences. In addition, he is widely quoted in interviews in the printed press and on the internet.
Mr. Rothbort founded LakeView Asset Management in 2002. Prior to that, since 1991, he worked at Merrill Lynch, where he held a wide variety of senior-level management positions, including Business Director for the Global Equity Derivative Department, Global Director for Equity Swaps Trading and Risk Management, and Director for secured funding and collateral management for the Global Capital Markets Group and Corporate Treasury. Prior to working at Merrill Lynch, within the financial services industry, he worked for County Nat West Securities and Morgan Stanley, where he had international assignments in Tokyo, Hong Kong and London. He began his career working at Price Waterhouse from 1982 to 1984.
Mr. Rothbort received an M.B.A., majoring in Finance and International Business from the Stern School of Business, New York University, in 1992, and a B.Sc. in Economics, majoring in Accounting, from the Wharton School of Business, University of Pennsylvania, in 1982. He is also a graduate of the prestigious Stuyvesant High School in New York City. Mr. Rothbort is married to Layni Horowitz Rothbort, a real estate attorney, and together they have five children.