Investors have not had a good time over the past six months. After Tuesday's big selloff, the Dow Jones Industrial Average was barely positive year to date, while the SPDRS&P 500 (SPY) clung to a 4.7% gain and the small-cap Russell 2000 booked a 7.5% decline (excluding dividends).
What seemed like non-stop gains from around February 4, 2014, appeared to run out of steam in July.
Since then, the SPY hasn't fallen too badly but smaller stocks have been hit hard. The Russell 2000 reversed from a greater than 4% gain to a 7.5% decline. Ouch.
Everyone seems to be positioning for an even more severe downturn. That means selling into weakness and building cash reserves.
But is that the right course of action?
It depends on both your mindset and your investment horizon. Trend-followers will be exiting long positions and adding shorts. Value seekers are probably stocking up on beaten-up shares.
One major long-term factor to consider is the market's behavior in the 12-months following national midterm elections. There have been 17 since 1946.
The periods from Oct. 31 of an election year until the same time the next year recorded positive results 100% of the time. The average one-year return was a very favorable 17.5%, with eight of the 17 post-midterm periods performing better than that 17.5% average. Just four of 17 failed to reach double-digit gains, including the 1986-87 period, which posted a gain of just 3.2%. That's still impressive, though, considering the stock market crashed on Oct. 19, 1987.
We are now just weeks away from this historically good time to be in the market. The high fear factor and sharp selloff is just what is needed to purchase high-quality stocks at the best prices of the year.
The 11 previous periods of extreme fear since October 2011 each preceded rebounds to new record highs on the SPY and DJIA. Every pullback was scary and painful while it happened. Every one proved to be a buying opportunity rather than a reason to sell at bad prices.
We may or may not have seen the worst of the current retracement. History tells us that you should be selectively added to positions, getting ready for the post-election action. Doing anything else means flaunting historical trends that sport 100% success rates.