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Fair Warning: Things Could Get Ugly! image

Let's start out today's oftentimes meandering morning market missive with a question. Is there anyone out there who expects the stock market to decline in the month of December? Well, other than those die hard perma-bears who have a tendency to expect the stock market to decline every month, that is? Didn't think so.

So, the first point this morning is that with the S&P 500 still up more than 25 percent on the year and history suggesting that the Santa Claus rally will bring good tidings to investors, most folks may be expecting that an advance for the market indices in December is a slam dunk. After all, everybody knows that year-end "window dressing" tends to boost prices at the end of a year in bull markets, right?

Something Everyone Knows...

However, as Ned Davis is famous for saying, "Something everyone knows in the stock market isn't worth knowing." In other words, if everybody knows about a market tendency, it isn't long before it stops working.

As such, perhaps it isn't a good idea to get too comfortable with the expectation that stocks will soon pull out of their now five-day old funk and resume marching ever higher into the New Year.

Yet at the same time, stocks DO tend to rally in December. As well as into January, February, and March. As anyone who knows their market history can attest, the November through April period has historically been the best time of year to be invested in stocks. And for anyone not familiar with this seasonal pattern; look it up, you will likely be amazed.

In addition, sometimes things in this game become "self-fulfilling." This means that although everyone can't be right all the time, if enough folks are thinking along the same lines, group-think can take over. (This is why most bull markets last longer than the bears can ever imagine.) So, just because "everyone" expects the market to advance in December, doesn't mean it won't!

Just Don't Get Too Comfy

Okay, time to move forward and talk about something that "everyone" doesn't know about. Although history does indeed support the idea that stocks will likely advance in the first quarter of next year, most investors probably are not familiar with what tends to happen in the second quarters of the second year of a President's term (aka the mid-term year).

Cutting to the chase - it isn't pretty! You see, bear markets have a nasty habit of showing up during the second year of the four-year Presidential cycle. And for some reason, a great many market peaks tend to occur in the second quarter of those mid-term years.

How Bad Will It Be?

Since 1934, there have been twenty such mid-term years. If one measures the decline from the prior high to the low of the mid-term year, the average decline measures -21.4 percent (and the median decline is -21 percent). Ouch!

For example, the last mid-term year was 2010. The high was seen in April and the low was in July. If you will recall, Europe caused some difficulties for the market that year (and the next, and the next). The total decline seen was -16 percent. In 2006, the decline was -7.7 percent. In 2002, it was -33.8 percent. And on it goes.

Sometimes It's Bad... Very Bad

Some years, the pullback is modest - somewhere in the 2 - 5 percent range. And then in other years, a full-fledged bear market takes place. In fact, exactly one-half of the mid-term years have produced declines of 20 percent or more, which is the base-level definition of a bear market.

And here comes the really scary part. The average decline experienced during those bear market years has been nearly 30 percent (29.79 percent to be exact).

So, while anything can happen in this game, investors (especially those who are uber-bullish at this time) may want to be on the lookout for any type of negative catalyst (Fed tapering perhaps?) in the coming months. Because, if something out of the blue crops up, history shows things could get ugly in a hurry.

Positions in stocks mentioned: none


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