US equities have had a difficult time since April of this year as fears over a double dip recession, a stubbornly high unemployment rate, and the possibility of slowing corporate profit growth have weighed on the markets. In addition, small investors are pouring money into bond funds sending yields crashing through the floor while equities are being labeled as risky investments.

But one of the great trading cycles is getting ready to flash a contrarian buy signal to the markets.

The four year Presidential Cycle looks for higher returns during the last two years of a Presidential term than the first years. The expectation is that as a President takes office he begins to implement his proposals and investors, hunker down waiting to see the results. During the final two years the President becomes more concerned with his re-election and will ‘prime the pump’ in order to secure re-election.

As we move through the second year of the Presidential Cycle a low is put into place which often leads to a solid rally into the third year.

I would like to bring to everyone’s attention an important article written by Bill Hester of the Hussman Funds entitled Business Cycles, Election Cycles and Potential Risks.

The chart on Election Cycle Returns shows that during year 2 of the Presidential Cycle the first quarter is up on average while the second and third are down leading to a rally in the fourth quarter which lasts into 2011.

So far in 2010 the stock market is following the chart perfect with a move up in the first quarter followed by pullbacks in the second and third quarters of the year.

We may be near a bottom in the equity markets as September is the worst month on average for equities. We are likely to see some continual downside pressure to equities during the September time frame as continued weak economic reports and concerns over third quarter profits will dominate the news flow.

The AAII Investor Sentiment Index last week reached levels which foreshadow the beginning of an upcoming rally in the equity markets.

Yields on corporate bonds and Treasury securities are at extremely low levels on an historical basis while dividend yields on high quality blue chip equities are at very attractive levels. Small investors would do well to begin preparing for the next big rally by having some cash on hand ready to allocate when the next buying opportunity approaches in the coming months.

While the news flow for equities may be negative small investors should look ahead to the light at the end of the tunnel signaling an upcoming rally, one which may catch many market watchers by surprise.

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