Market wisdom that withers on a closer look
NEW YORK – Everybody knows that January predicts the stock market’s direction for the year and that the best time to sell stocks is at their spring peak. And among stock market experts, it’s a sure bet that the market will soar in the year before an election.
But what passes for stock market wisdom is suspect when given a closer look. The most common error comes when people spot two events and assume that one causes the other.
And it drives economists, math geeks and plenty of money managers nuts.
“If you look at enough data in enough different ways, you’re going to find something that isn’t really true,” says Edward Keon, who leads a mathematics team at Prudential Financial.
The same seasonal patterns seem to pop up year after year. Some are valuable and some meaningless, Keon says – like saying stocks tend to rise or fall depending on the month, the temperature in New York City or who wins the Super Bowl.
People “are simply being fooled by randomness,” says Burton Malkiel, professor of economics at Princeton University and author of the finance classic “A Random Walk Down Wall Street.”
Spend enough time digging through numbers and you’re bound to find some that always take the same path, he says. “But none can reliably predict the future.” Here’s an examination of some of the oldest Wall Street aphorisms.
The claim: As goes January, so goes the year.
The idea is that January works as a barometer for the stock market’s full-year performance: A strong first month often leads to a year of gains, and a weak one to a year of losses.
It comes from Yale Hirsch, father of the Stock Trader’s Almanac, and looks reliable. Since 1929, the calendar year has followed January’s lead 60 out of 83 times, according to Howard Silverblatt, senior index analyst at Standard & Poor’s.
That’s a .723 batting average.
The suggestion that January somehow directs the course of the next 11 months is what irks economists and investors, including Dan Greenhaus, chief market strategist at the brokerage BTIG.
Expecting to hear praise for January’s forecasting powers, Greenhaus attacked the idea on his blog Jan. 2, the day before U.S. markets opened for 2012. He took the S&P 500 index’s returns since 1950, including dividends, and found that the three months following January also appeared to work magic. When April is down, the next 12 months return a negative 0.2 percent. When April is up, the S&P 500 returns 12.8 percent. It’s a similar story with February, March and April. But why?
“It’s true that if January is up, the year is up most of the time,” he says. “But if you look at any month, you’ll find the market tends to be up over the next 12 months. And the reason is very simple: the market tends to be up.”
The S&P 500 has climbed in three out of every four years since 1950. Pick nearly any month in which stocks rose and most of the time you’ll find that the year was headed in the same direction.
But what if stocks fall in January? It doesn’t mean the next 11 months will follow. Sometimes, the stock market starts the year in a hole and digs its way out. In 1992, the S&P 500 dropped 2 percent in January, then ended the year with a modest gain of 4.5 percent.
“If you’re starting in the hole, then the 12-month period is starting in the hole,” Greenhaus says. “That should be intuitive. Instead it gets treated as some sort of prognostication tool. It’s just what happens.”
The claim: Sell in May and go away.
Like a flock of migrating birds, the stock market tends to travel south or north depending on the season. It rises through the winter months and falls late in the spring. Investors struggle through the summer until November rolls around and the market picks up again.
“Sell in May and go away” is a well-worn saying, but the numbers seem to back it up. Since 1990, the three months starting in July have been the worst quarter for the S&P 500. Last year, the S&P hit its peak on April 29, then hit bottom Oct. 3, right on cue.
Even many skeptics think “sell in May” probably has something going for it – but they can only guess why.
“It’s harder to debunk this one,” says Nick Colas, chief market strategist at ConvergEx Group.
The flow of money into retirement plans and mutual funds may have something to do with it. Colas says databases that track cash moving into tock funds show patterns similar to the stock market trend: A strong start that evaporates as the year progresses.
In the first four months of 2011, Americans added $13 billion to U.S. stock funds, according to the Investment Company Institute. But they pulled $6.5 billion in May and then began withdrawing much more. By the end of the year, retail investors had pulled $131.8 billion out of U.S. stock funds.
Some tie the summer sluggishness to vacation season. Trading desks are thinly staffed in the weeks before Labor Day. Fewer traders means a drop in trading volume, which makes it easier for markets to take bigger swings, often down.
Here’s where that explanation falls short. Traders return to their desks after Labor Day in September and trading picks up. But for all major stock indexes, September is historically the worst month of the year. Since 1950, it’s the only month in which the stock market has fallen more than it has risen.
The claim: The third year of a president’s term is great for stocks.
U.S. presidents serve four-year terms, and the third year is usually the best for the stock market. The pattern has been remarkably solid. The Dow Jones industrial average has made gains in every third year of a president’s term since 1939, when President Franklin Roosevelt was nearing the end of his second term in office. Looking back even further, the Dow has gained 10 percent on average in the third year of a term from 1835 through 2007, according to the Stock Trader’s Almanac.
Last year, President Barack Obama’s third in office, the Dow added 5.5 percent. The next best is the election year, when the Dow has gained an average 5.8 percent.
To Keon, managing director of Prudential’s Quantitative Management Associates, the problem with banking on a president’s third term for a market rally is that it only considers two things, the stock market and the president, and ignores everything else.
Keon believes there’s something behind the long-running pattern, just not as much as many believe.
Sitting presidents want to get re-elected and may try to push spending packages to boost the economy, Keon says. He ran a study that examined the effects of interest rates, inflation and other economic activity, and the president’s ability to move markets largely disappeared.
Last year, even though the Dow turned in a modest gain, the larger S&P 500 index was flat. The best performing investments weren’t stocks but those that doubled as hiding spots from turbulent markets: U.S. Treasurys and municipal bonds.
“The market cycle is beyond the control of the political system,” Keon says. “What matters more is investors’ appetite for taking on risk.”
By MATTHEW CRAFT, AP Business Writer Sun Jan 8, 5:00 pm ET
Evan S. Russell, CFP®, Stacy L. Rerick, CFP®, Ronald E. Wilkinson, CFP®