By Jeffrey A. Hirsch
Stock Trader's
Almanac Investor

       While we still foresee a broad trading range for the next few years, the prospects for 2004 are bright - perhaps not as much so as 2003, but positive nonetheless.
       But after the 2004's Election year bull market continuation, we expect 2005 and 2006 to be softer with a Midterm bottom in 2006.

        One interesting sign to watch is what the market does in the first four months of 2004. In the previous election years starting with 1952, the market lost ground six out of thirteen times. On five of those six losses the incumbent party was ousted, in 1952, 1960, 1980, 1992 and 2000. Reagan in 1984 was the exception.
       Since 1944, stocks tend to move up earlier when White House occupants are popular but do even better in November and December when unpopular administrations are ousted.
       Election years are traditionally up years. Incumbent administrations are generally attempting to massage the economy so voters will keep them in power. But sometimes overpowering events occur and the market crumbles, usually resulting in a change of political control.
        The Republicans won in 1920 as the post-war economy contracted and President Wilson ailed. The Democrats came back during the Depression when the Dow hit its lowest level of the 20th century. A world at war and the fall of France jolted the market in 1940 but Roosevelt won an unprecedented third term. Cold War confrontations and Truman's historic upset of Dewey held markets down through the end of 1948.
        Since 1948, investors have rarely been bruised during election years, except for a brief span early in the year - until 2000. An undecided election plagued the country with uncertainty, hammering stock prices. Nasdaq off 39.3%
        Most significant though are the last eight months and last seven months of Election Years. There were just two losing last-eight-month periods in an election year since 1952 and not one loss in the last seven months of all these years until the undecided election in 2000.
       Another election-year phenomenon is the Post-Convention-to-Election Day Forecaster. The direction of the Dow between the close of the last Presidential Convention and Election Day reflects voter sentiment. Of the sixteen presidential elections since 1900 where the incumbent parties were victorious, fourteen were foretold by rising stock prices. Gains for the period averaged 8.6%. Conversely, dissatisfaction with an incumbent party is most times reflected by a decline between the last convention and Election Day. Here, seven out of ten election years produced declines. Excluding 1932, the average election year lost 1.6% when incumbents were ousted.
        Notwithstanding extrinsic events, a heavily favored Bush would likely mean a bullish climate from the last convention to the election. If the President's popularity is waning, look for market declines or sideways action. This is also the case for 2004 as a whole.
        Does the government manipulate the economy to stay in power? Statistical evidence proves that in years divisible by "4" the party in power turns on the money faucets. The "making of presidents" is accompanied by an unsubtle manipulation of the economy. In all fairness, it's in the President's job description to create a healthy economy and market climate.
       Under Reagan we paid the piper in 1981 and 1982 followed by eight straight years of expansion. However, we ran up more deficits than the total deficits of the previous 200 years of our national existence.
       Alan Greenspan took over the Fed from Paul Volker in August "87" and was able to keep the economy rolling until an exogenous event in the Persian Gulf pushed us into a real recession in August 1990 which lasted long enough to choke off the Bush Senior re-election effort in 1992.
       Three other incumbents in this century failed to retain power: Taft in 1912 when the Republican Party split in two; Hoover in 1932 in the depths of the Great Depression; and Carter in 1980 during the Iran Hostage Crisis.
        Bill Clinton, warts and all, presided for two terms over the incredible economic expansion and market gains of the nineties. Mr. Clinton was wise to have former Goldman Sachs chief, Robert Rubin, run the treasury for a stretch, helping his administration create a smooth and beneficial relation-ship with Wall Street, Main Street and the Fed.
        George W. Bush's political front is split in two. One half is still engaged in Iraq, Afghanistan, and elsewhere overseas while the other if focused on stimulating the economy and the stock market. Major tax cuts have already passed, including a bone to Wall Street in a dividend tax cut. Pre-election 2003 is delivering as promised with strong market gains after a recession and war plagued 2001-2002. Though no Democratic contender poses a threat yet, Mr. Bush will have to do all he can to avert economic setbacks and market declines as the election approaches.
       The stock market is basically a popularity poll. Excepting exogenous events, markets tend to do better when incumbent presidents are reelected, rather than ousted.
        If you tally up the twelve occasions in the last 100 years when elected presidents ran for reelection, you get an average gain of 7.4 percent on the Dow when incumbents are reelected, compared to 0.9 percent on average when they lose.
        Of the eight winners, four running during wars (or when there was a threat of war) saw average gains on the Dow 2.9 percent. Gains for the four others, Roosevelt, Eisenhower, Reagan, and Clinton, averaged 12.4 percent.
        Guessing which party will win an election can help you get on the right side of the market. Of course, guessing right isn't the easiest thing. What if things get uglier in the Middle East? What does Bush have to do to win reelection in November 2004? Remember Bush Sr. was fairly popular after the Persian Gulf in 1991 but blew it in 1992.
        By our reckoning the current rally, or cyclical bull if you wish, should encroach on 11,000 by mid-2004. The two main forces are the stimulus from the Bush administration that so often accompanies an incumbent's reelection bid and the recovery off the initial bottom of the recent historic bear market.
       After that, the potential for an Election-Year top increases, depending on Mr. Bush's popularity. Eight market tops have occurred in Election Years since the depression, most recently in 2000. Signs of the economic recovery are clearer at the present time.
        We may not have seen the end of the millennium bear. It is hard for us to believe that after 17 years of side-ways-to-bearish market action from 1966 to 1982 and 18 years of bull from 1982-2000 that the market will turnaround and be an all-out bull again.
        Both periods experienced substantial peaks and valleys, as will the next several years as we work off the excess of the eighties and nineties. Look back to the market after 1929 crash and 1932 bottom. You'll see quite a bit of oscillation. And, the market did not move firmly above its old highs until the late 1940s.
        As the spring approaches, it may be a tough slog for the President if there are any clearly leading Democratic candidates focusing their slings at Mr. Bush and the populace begins to redirect its attention from the markets to the campaign trail.

        Powerful Presidential Election Year forces will still be in play in 2004. Presidential elections in the U.S. every four years have a profound impact on the world, the economy and the stock market. This symbiotic relationship between Washington and Wall Street is hard to ignore. War, recessions and bear markets tend to start or occur in the first half of the term; prosperous times and bull markets, in the latter half. That's clearly been the case for Mr. Bush's first term so far.
        2004 will likely be a dynamic year for investors. Election years tend to be battlegrounds and anytime a president is faced with reelection, obstacles present themselves. President Bush's popularity should firm up with Saddam under wraps. This will bode well for stock prices as positive market action usually accompanies the reelection of a president.
        Though no president who lost the popular vote has ever won a second term, President Bush's prospects to beat these odds and be reelected continue to improve. The White House usually changes hands after a war turns sour or ends (1920, 1952, 1968, 1992), but the situation in Iraq looks likely to continue so that a "wartime" president is up for reelection. If the situation in Iraq gets out of control and becomes an embarrassment it could hurt the Republicans at Election time and hence the market. Also, the Democrats have yet to field a formidable contender.
        Many market pundits are concerned about a whole host of things: high valuations, over-zealous sentiment, trade imbalances, the weak dollar, the jobless recovery, etc. There are also a fair amount of bullish forecasts out there. From our advantage point it looks about even. In general, this tug-of-war is healthy for the market right now. Markets do climb walls of worry. This battle has already created solid support and steady uptrend.
       Though many these days suspect the prescience of the Dow 30 Industrials, we still find the gauge useful as a leading indicator. It may not provide the fuel needed for an extended bull market - that always comes from small stocks and new leaders - but the multinationals sure know the way. They also represent a microcosm of the U.S. economy, and in turn, the world. If these behemoths can do well, smaller, more nimble companies, with new innovative products and services can certainly do better. The Dow was the first index to top out in 2000 - in January -ahead of the major meltdown. With smaller shares taking a breather at the moment the Dow is pointing to another leg up.
        The dollar situation is not horrible. If anything it keeps our trade balance a little in check. He, somebody has to be the world's consumer. Besides, if the dollar were so weak why wasn't Saddam carrying 750K euros? Central banks will not let the dollar plummet. It does not do anybody any good.
        Economic growth is just beginning to pick up. Third quarter GPD is a case in point. Next year's forecasts are in the 4% range. Job recoveries lag by nature and they are bound to follow this time around. We're seeing the beginnings of that in the employment numbers already.
        Inflation remains in check so interest rates are not going anywhere fast. As the commodity boom proceeds, fueled by the developing world - especially in Asia - and economic recovery in the US and the rest of the developed world, mild inflation will resume and rates will tick up.
       That may provide short term buying opportunities as the market reacts but all it really means is growth, pricing power and an improving business climate. Business spending is also increasing in concert with industrial production and capacity utilization. It's also comforting to see IPOs on the rise.
        Have no fear, if the economy does falter the Bush administration has the ability and the wherewithal to further stimulate the economy. All these Election year forces plus an improving economy lead us to our bullish outlook for the Dow to tack on an additional 10-20% and top out near the year 2000 highs of 11,700. From current levels that's about 15%.
        The S&P and the Nasdaq won't be able to reach their 2000 highs. The S&P will keep pace with the Dow for the most part and get into the 1200 area. Nasdaq will surpass these gains and likely pass 2500 and encroach 3000 - still well below its millennial high-water mark. We'll be on the lookout for an Election year top but if Mr. Bush remains popular and the economy continues to roll along, that top will come closer to year-end or early 2005.
We'll continue to focus on undervalued small cap in specialty fields, high-tech and natural resources as well as our seasonality strategies.
       Editor's Note: Jeffrey Hirsch is editor of Stock Trader's Almanac, 184 Central Ave., P.O. Box 2069, Old Tappan, NJ 07675, 1 year, 12 issues, $295. The Hirsch Organization are also publishers of The 2004 Stock Trader's Almanac. Visit the Web site at www.stocktradersalmanac.com.
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