Two Views on the Markets' Weakness

02/23/2009 12:00 pm EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of The Chartist, says stocks’ weakness early this year may be a warning signal for the market.

The Standard & Poor’s 500 index plunged 8.6% in January—its worst ever start to a new year in history. The previous mark was a 7.6% drop in January of 1970. Based on the old adage “as goes January so goes the year,” the market’s decline is a bad omen for 2009. (It’s down another 6.8% so far in February, for a total drop of 14.7% for the year to date—Editor.)

According to the Stock Trader’s Almanac, the month of January predicts the future direction with reliable accuracy. Since 1950, there have only been five periods when the market went the opposite direction of the trend set during the first month. That works out to a 91.4% success rate.

There is one caveat, however, with the January Barometer: If it is to be used as a predictive measure for the remainder of the year—February through December—then January should be omitted from the results. If you view it through this window, then its success rate is not nearly as impressive. In fact, if stocks decline in January, there’s just better than a 50/50 chance that the market will follow suit for the remainder of the year. When January shows a gain, the ensuing 11 months have also shown a gain about 67% of the time.

Our advice remains the same: Stay 100% in money market funds.

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James Stack, president of InvesTech Research says we can’t rely on the indicator’s track record.

With January turning in an 8.6% loss and market averages retesting recent lows, many historian pundits on Wall Street are pointing to the ominous message of the proverbial January Barometer. “As goes January, so goes the rest of the year” has been a popular Wall Street truism for decades. And at least superficially, the accuracy seems convincing.

Over the past 81 years, the January Barometer has proven fairly accurate. If January was “up,” then the rest of the year saw market gains… and if January was “down” then the rest of the year saw losses… 68% of the time. So, 32% of the signals were incorrect

One problem is that a 68% accuracy isn’t all that great. Since the stock market rises in two-thirds (65%) of the years, one could simply say on January 1st, “I think the stock market will go up this year” and be correct almost as often as the January Barometer.

Another less obvious problem is that the accuracy drops significantly for the January Barometer if January was a “down” month—as it was this year. In fact, in that case (a losing January), the January Barometer turns out to be wrong more frequently than correct: 52% vs. 48%.

In addition, the five biggest January losses over the past 81 years have all seen the stock market rise between February 1st and the end of the year.

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