The Presidential Election cycle is well known, but how many investors are aware of the equally powerful “decennial cycle?” Historically, the best buying opportunities have been in years like this, ending in 2. It’s not magic, witchcraft, or numerology. There’s a “secret sauce” behind most of these gains, one that could be applied with great effect in 2012 as well. I’ll reveal that sauce in a minute, but first the facts:

Going back to 1881, The Almanac Investor has calculated the returns for each year in the last 13 decades. They found that the first five years (ending in zero through 4) delivered 7.8% gains (just 1.5% per year), while the second half of the decade delivered a whopping 67.5% gain! Here’s the recent track record:

Of particular interest in this year, 2012, we can see that the market bottomed out in three of the last five decades during a year ending in “2,” followed by a meteoric rise, peaking about five years later:

Now let’s look at those three cycles in a bit more detail to see what they might have in common:

1962 – JFK’s Tax Cuts Lifted the Market (Despite a Missile Crisis)

Most investors assume that the market crash of 1962 was caused by the Cuban Missile Crisis, but stocks actually rose in October, the month of the crisis. The 1962 crash was caused by a war of words between President John F. Kennedy and U.S. Steel in the spring. Then, the Dow actually rose 16.2% in the second half of 1962 on its way to an 85% gain despite inflation and the Vietnam War. What caused the rise?

In this political season, it’s interesting to note that a Democratic incumbent favored “across-the-board” tax cuts 50 years ago. On Monday, August 13, 1962, President Kennedy promised an “across-the-board, top-to-bottom” tax cut in corporate and personal rates to take effect in 1963. The Dow shot up 3% that week launching the 16.2% second-half gain. Kennedy’s tax cuts were delayed in Congress, but the next President, Lyndon Johnson, followed up on Kennedy’s promise in 1964, accelerating the market’s gains.

The “Kennedy-Johnson” tax cut (the Revenue Act of 1964), signed into law on February 26, 1964, cut the top rate from 91% to 70%, while all other rates fell and a standard deduction was added. Prosperity soon erupted: The jobless rate fell from 5.2% in 1964 to 3.8% in 1966 and 3.5% in 1969, the lowest rate in the last 50 years. Initial fears of a loss of revenue were forgotten when tax revenues increased each year – so much so that the federal budget was balanced (with a surplus!) in 1969 despite LBJ’s “guns and butter” (war and welfare) spending, plus the project of landing men on the moon and the launching of Medicare.

1982 – Volcker “Blinks” and the Market Gains 33% in 10 Weeks

Between two “double-dip” recessions, the Kemp-Roth tax bill (the Economic Recovery Tax Act of 1981), passed into law August 4, 1981, reduced the top income tax rate from 70% to 50% while phasing in 25% cuts in individual rates over three years: 5% cuts in 1981, 10% cuts in 1982, and another 10% cut in 1983.

If you think today’s economy is terrible – or even “the worst since the 1930s” – then you need to take a second look at 1982. The national unemployment rate surpassed 10% for 10 straight months, peaking at 10.8%. From mid-1979 to late 1982, the U.S. economy contracted in real terms for 14 quarters. We also had double-digit inflation and a Prime Rate of 21.5%. The Fed’s Discount Rate was 12% in mid-1982.

But then, in August 1982, Fed Chairman Paul Volcker cut the Discount Rate a full point, from 12% to 11%. He lowered the Discount Rate five more times in the second half of 1982 to 8.5%. Short-term (90-day) T-bills declined from 13.3% to 7.8% in the third quarter of 1982, and banks lowered their Prime Rate from 21% to 13%. The bull market was born. After setting a Vegas-style low of 777 on lucky Friday, August 13, the Dow surged 10% the following week, 33% in 10 weeks, and 250% in five years.

As a result of ERTA and other tax acts in the 1980s – called then, as now, a “tax cut for the rich” – the  richest 10% paid 57.2% of total income taxes by 1988, up from 48% in 1981, while the share paid by the bottom 50% dropped from 7.5% to 5.7% in the same period. The “secret sauce” worked yet again.

The Market Doubling of 2002-07 Followed the Same Pattern

After the long and lingering crash of 2000-02, we saw something similar happen in the middle of the last decade, with the S&P 500 rising 105% from its October 10, 2002 low to its October 10, 2007 peak. Most of the gains came after the Jobs & Growth Tax Relief Reconciliation Act of 2003 was signed into law on May 28, 2003, reducing the top tax rate to 35%, while cutting long-term capital gains and dividend rates sharply. The resulting prosperity engendered more tax collections, not fewer. After the Bush tax cuts of 2003, the federal deficit shrank each year – until the real estate bubble and the financial crisis of 2008:

During the same four years, the percentage of federal income taxes paid by the top 1% vs. the bottom 90% grew from rough parity (34% each) to a 12% spread in favor of the bottom 90%:

The reason is as obvious (and controversial) as when President Kennedy said it 50 years ago this week.

“A bill will be presented to the Congress for action next year. It will include an across-the-board, top-to-bottom cut in both corporate and personal income taxes. It will include long-needed tax reform that logic and equity demand … The billions of dollars this bill will place in the hands of the consumer and our businessmen will have both immediate and permanent benefits to our economy. Every dollar released from taxation that is spent or invested will help create a new job and a new salary. And these new jobs and new salaries can create other jobs and other salaries and more customers and more growth for an expanding American economy.”– John F. Kennedy, August 13, 1962, in a national radio/TV broadcast.