Obama Effect: Timing an Early Rally and Long Positions

Today is Martin Luther King Jr. Day in the US, a federal holiday marked as a national day of community service. Tomorrow Mr. Obama will be sworn in as the 44th president of the United States. For most Americans and others around the world, this historic moment offers the promise of renewal and the hope that comes with a different approach to the difficult problems of our times.

As reported in a January 13 article entiled 'Buy Stocks On Expected Obama Rally', President-elect Obama’s plans to stimulate the economy "should create an Obama rally in the early days of his presidency." The author of this article recommends, "taking select long positions. Look for stocks that are exhibiting bullish signs in early trading and start accumulating positions. There are risks, as we are now entering earnings seasons, as well as economic related news to contend with, but in all, traders should be able to score some points off the incoming administration."

Although Obama's proposed policies have been well received by most, markets fear the uncertainty of change. In an Option's Zone article, John Jagerson suggests we should pay very close attention to Presidential cycles. "there are some very consistent statistics about presidential terms that may help us make some estimates about the next four years. What we found is that it really doesn't matter who the president is, but that it is someone new and that the cycle of presidential life has begun again."

"Statistically, over many administrations, an unusual pattern has emerged." This is what is known as the presidential stock market cycle. The data reveals that historically the first year of a president's term offers a very modest gain for stock markets (4%), the second year is little better (6%), the third offers the most substantial returns (18%), and the fourth is stronger than the first and second years but not as strong as the third (10%). The pattern holds true whether you use small caps or large caps or a mix of small and mid-cap stocks.

Jagerson explains it this way, "The excess governmental activity in the first year creates a lot of uncertainty. By the time the third year comes around, the administration is typically "retrenching" and trying not to mess up too much before they have to run for office again. That slowdown in activity may remove some of the uncertainty in the market, which could be one explanation for the boost in the third year."

The Obama Effect will benefit some stocks, but in 2009 we are likely to see continued volatility as markets adjust to policy changes. "An aggressive and risk tolerant small-cap investor can provide a small hedge against a decline without eliminating the possibility of some profits. Covered calls on a small-cap ETF may be just the solution." The same author explains how "a covered call with an expiration of January 2010 can provide a hedge of 10% of the total value of the ETF while still providing the opportunity for 20% maximum profit, should the market rally. In some cases, this potential return could be much higher if you sold the covered calls on a month-to-month basis during the next year."

There are several key dates that Obama Effect investors should note. The oath of office and Presidential Address on January 20, and the passing of an Obama stimulus plan by Congress (within the first hundred days). Wednesday, January 21 will be President Obama's first full day in office. He will convene a meeting of his top economic advisers and issue several executive orders on issues including the environment. (CNN reports that another option under consideration is an executive order raising fuel efficiency on automobiles.) When stocks move up after inauguration, lock in profits, and when congress starts debating an Obama infrastructure bill, assume long positions. During the week of February 23, look for President Obama to deliver a speech to a joint session of Congress underscoring the dire state of the economy.

Each president has had a legislative agenda which in turn effects different sectors of the stock market. Under Clinton tech stocks sky rocketed, under Bush it was oil, with Obama it will be renewable energy. Understanding how to earn short term profits before taking long term positions will provide investors with a good strategy for leveraging the Obama effect.