Here is my recent article for the Trading Deck at MarketWatch.com
By J.C. Parets
You hear about it everywhere you go: Santa Claus rally, January Barometer, First Five Days Indicator. These are all signs of a new year.
Some market participants find it pointless to remember that the market behaves in different ways during certain times of the year. But I think you’re selling yourself short if you ignore the fact that stocks do act in predictable seasonal patterns. The bottom line is that these patterns occur far too frequently to be just a coincidence. How else would you explain the fact that all of the stock market gains since 1950 have been during the months of November through April, compared to a loss May through October? (Think about that for a second before you keep reading)
With the Santa Claus rally boosting stock prices into year end, we can check that off and turn our attention now to the ‘First Five Days Indicator’. According to the Stock Trader’s Almanac, the last 38 “UP” first five days of the year were followed by full-year gains 33 times. This is an 86.6% accuracy ratio and a 13.9% average gain in all 38 years. I think these stats are nice to keep in mind as we close out the ‘first five days’ of 2012 with a 1.8% gain for the S&P 500 ($SPY).
Going forward, the final tally at the end of January should give us some further insight as to how the rest of the year should turn out. History shows that, as January goes, so goes the year . In other words, if the S&P500 closes positive for the month of January, then there is a high likelihood that the rest of the year should close in the black. According to the Trader’s Almanac, since 1950 this indicator has an 88.5% accuracy ratio.
There are some good reasons for this too. It isn’t just obsessive compulsive data mining like some casual market observers might believe. Remember, it is important for there to be correlations WITH causation. In the case of January, investors have typically just gone through a period of tax loss harvesting. By selling their dogs and going into the new year with some cash, they need to question whether they want to put money to work right away (if they believe the market is going to do well for the full year), or take a more conservative approach (if they are less optimistic about the new year).
If investors are willing to put money to work right away, not just for the month of January, but also in the first five days of the year, this shows conviction and a risk appetite out of an investment community that stands to benefit by holding on to stocks for a full year in order to receive the long-term tax benefits.
You can use the same logic to figure out why the top performing industries in the market for the month of January typically outperform the S&P 500 over the next 11 months. Sam Stovall from Standard & Poors does some great work on this indicator and calls it the, “January Barometer Portfolio”.
Seasonality is just one tool of many for a technical analyst. We analyze the behavior of the markets in order to give ourselves the best chances possible to manage risk while also trying to position ourselves to profit from market movements. This is a very difficult task.
Now it doesn’t always work out exactly the way history has shown, but the statistics are too convincing to ignore. In fact, according to the Stock Trader’s Almanac, every down January in the S&P 500 since 1950, without exception, preceded a new or extended bear market, flat market, or a 10% correction. If those numbers don’t make you look at least a little bit closer, then I don’t know what will.
If you had the choice of either having Jose Reyes and Ryan Braun in your batting lineup or on the other team’s line up, which would you choose? Well with those two guys leading the National League in batting average last year, I would hope that you’d choose to have them on your squad. Of course, in a given game can these guys go 0-8, and the minor league subs on the other team each hit for the cycle? Sure, but would you put your hard earned money behind that or would you prefer to be in the direction of the trend? (correlation with causation)
When analyzing these seasonal tendencies, we’re not going all in or making bold predictions about future market prices. But understanding the behavior of the stock market during certain times of the year can only help us to manage risk, and that is all we can ask for.
So far so good for the S&P 500 this year as the Santa Claus rally and First Five Days Indicator are showing positive signs for 2012. More importantly, the leadership has been in the right places. The best performing sectors of the year have been Basic Materials, Financials, and Industrials. The weakest areas have been in the defensive names like Staples, Healthcare, and Utilities. The market is telling us that money wants to flow into stocks and more specifically, into the offensive sectors. You want to see more of the same if these January Indicators are going to be proven right come a year from now.