Read an Excerpt

The Almanac Investor

John Wiley & Sons

Chapter One

JANUARY INDICATORS AND PATTERNS

January Almanac

January, namesake month of the Roman god of doorways and passages, Janus, has quite a legendary reputation on Wall Street. Our January Barometer (JB), of course, garners much of the notoriety with its .806 batting average since 1938. As the opening of the New Year, January is host to many important events, indicators, and recurring market patterns. U.S. Presidents are inaugurated and present State of the Union Addresses. New Congresses convene. Financial analysts release annual forecasts. Residents of Earth return to work and school en mass after holiday celebrations. Small stocks are rumored to outperform large stocks in the nom de guerre, the "January Effect." And, the largest number of our seasonal indicators occurs in January: Day two marks the end of our "Santa Claus Rally," the "First Five Days" is our first glimpse at the trading environment for the coming year and a whole month gain or loss of the S&P 500 triggers our January Barometer. Every down January on the S&P 500 since 1938, without exception, has preceded a new or extended bear market, or a flat year.

Ranked number one on NASDAQ and the S&P 500 (second on the Dow) the last 35 years, January ends the year's best three-month span. NASDAQ averages a 4.0% gain since 1971. January's whole month performance is impressive but this dynamic month is also packed with important seasonality and telltale indicators. As the New Year commences cash flows from year-end bonuses and portfolio restructuring increases and floods the market. Analysts and market strategists try to decipher the market's tea leaves for the year ahead making January arguably the most important market month of the year.

Typical January

Based on our market probability models January has a rather distinct typical trading pattern. The first trading day of the year starts slow and is frequently down before the effects of holiday revelry fully wear off-but the Dow has been up 10 of the last 15. It can be an opportune time to jump into the market, while traders are still groggy, ahead of a much stronger day two. Arguably one of the better trading days of the year-the Dow has also been up 10 of the last 15, second trading days gain ground a large majority of the time with hefty gains as more sober traders turn over a "new leaf" of positivity and ramp-up buying in the New Year. Day one has improved recently, apparently in anticipation of day two's stellar record.

Over the next several days markets fluctuate with a slightly bearish bias. Then equities come alive around the tenth trading day of the month as the first mid-month 401(k) cash infusion is injected into the market. Buying also swells ahead of, and after, the first three-day weekend of the year, Martin Luther King Jr. Day. The Dow has been up 6 of the last 8 first days of expiration week-the day after MLK day is also an official bullish day. After this two-to-three day spurt stock prices sell off and meander until month-end. January expiration day has seen the Dow down five of the last six, but 2004 broke a 5-year losing streak. As January comes to a close stocks head higher with the last day of January being one of the strongest days of the year.

January's First Five Days "Early Warning System"

Two early warning indicators surface the first several days of the month, the Santa Claus Rally and January's First Five Days. The seven-day Santa Claus Rally, which averages 1.6% for the S&P 500 since 1969, ends on the second trading day of January. This brief, reliable indicator is more significant in its absence. Times when this typical end-of-year bullishness has been missing have preceded bear markets or corrections.

January's First Five Days can provide a preliminary gauge of the year to come-especially when they are up. Since 1950, 35 up First Five Days on the S&P 500 were followed by 30 full-year gains for an 85.7% accuracy ratio and a 13.8% average gain in those 35 years. The five exceptions include flat 1994 and four related to war. Vietnam military spending delayed start of 1966 bear market. Ceasefire imminence early in 1973 raised stocks temporarily. Saddam Hussein turned 1990 into a bear. The war on terrorism, instability in the Middle East, and corporate malfeasance shaped 2002 into one of the worst years on record.

The 20 down First Five Days were not indicative-up 10, down 10. In Post-Election Years however, down First Five Days can be telling. Eight of the last thirteen times the S&P 500 posted a loss for January's First Five Days-six of these eight were followed by full-year losses averaging -11.1%. Five Post-Election First Five Days showed gains and four years followed suit gaining 22.6% on average.

In Midterm Election Years this indicator has had a spotty record-almost a contrary indicator. In the last 14 Midterm Years only six full years followed the direction of the First Five Days and none did in the last seven. The full-month January Barometer (see below) has a better Midterm record of 64.3% accurate.

Pre-Election years start with a stacked deck-none have been down since 1939. Only two First Five Days were down (1955 and 1999). Both years posted S&P 500 gains of over 26%. Election Years have followed the direction of the First Five Days 12 of the last 14 times though the S&P 500 has been down only twice in Election Years since 1950.

The Incredible January Barometer

Devised by Yale Hirsch in 1972, our January Barometer has registered only five major errors since 1950 for a 90.9% accuracy ratio. This indicator adheres to propensity that as the S&P goes in January, so goes the year. Of the five major errors Vietnam affected 1966 and 1968; 1982 saw the start of a major Bull market in August; two January rate cuts and 9/11 affected 2001; and the market in January 2003 was held down by the anticipation of military action in Iraq. (Almanac Investor newsletter subscribers were warned at the time not to heed the January Barometer's negative reading as it was being influenced by Iraqi concerns.) Including the six flat years yields a .800 batting average. Bear markets began or continued when Januarys suffered a loss. (See Down Januarys, page 12.)

Excluding 2001, full years followed January's direction in the last 13 Post- Election years. Midterm Years tracked January's direction 9 of the last 14. With the dice loaded for Pre-Election Years as mentioned above, the JB has a 13-and-1 record, the only loss in 2003 due to exogenous events ahead of the military action in Iraq. Ten of the last 14 Election years have followed January's course.

1933 "Lame Duck" Amendment - Why JB Works

Passage of the Twentieth "Lame Duck" Amendment to the Constitution in 1933 created the January Barometer. Since then it has essentially been "As January goes, so goes the year." January's direction has correctly forecasted the major trend for the market in most of the subsequent years.

Prior to 1934, newly elected senators and representatives did not take office until December of the following year, 13 months later (except when new presidents were inaugurated). Defeated congressmen stayed in Congress for all of the following session. They were known as session. They were known as "lame ducks."

Since 1934, Congress convenes in the first week of January and includes those members newly elected the previous November. Inauguration Day was also moved up from March 4 to January 20.

January's prognostic power is attributed to the host of important events transpiring during the month: new Congresses convene; the president gives the State of the Union message, presents the annual budget, and sets national goals and priorities.

These events clearly affect our economy and Wall Street and much of the world. Add to that January's increased cash inflows, portfolio adjustments, and market strategizing and it becomes apparent how prophetic January can be. Switch these events to any other month and chances are the January Barometer would become a memory.

The table at right shows the January Barometer in odd years. In 1935 and 1937, the Democrats already had the most lopsided Congressional margins in history, so when these two Congresses convened it was anticlimactic.

The January Barometer in subsequent odd-numbered years had compiled a perfect record until two January interest rate cuts and 9/11 affected 2001 and the anticipation of military action in Iraq held the market down in January 2003. January is compared to prior "New Congress Barometers" below.

Almanac Investor Platform subscribers are emailed the official final results of the January Barometer after the close at the end of every January.

New Congress Barometers

Between 1901 and 1933 the market's direction in January was similar to that of the whole year 19 times and different 14 times. Comparing January to the 11 subsequent months, 16 were similar and 17 dissimilar.

Prior to the Twentieth Amendment in the last century, we had a "March Barometer" when newly-elected presidents (Taft, Wilson, Harding, Hoover, and Roosevelt) were inaugurated on March 4. Newly elected Congresses convened in March for the occasion. Score 5 out of 5 for the "March Barometer" prior to the Twentieth Amendment.

Between 1900 and 1933, eight new Congresses convened on the first Monday in December (13 months after the election). But because of annual year-end reinvestment, it would be misleading to use December as a barometer. We used a "November Barometer" instead and the score was almost perfect. In 1903, the only time Congress actually convened in November, the barometer was in error. The Panic of 1903 took the Dow down 37.7% and the new Congress was called in one month earlier, ostensibly to "stem the tide." The Panic ended on November 9, the day Congress convened, but the month remained negative while the market moved up over the next 11 months.

Three other new Congresses were convened in other months for different reasons-April in 1911 and 1917 and May in 1919. The record is a double bulls-eye for the "April Barometer." As for the one-shot "May Barometer" a post-Armistice 30.9% surge in four months (February to May) took May up 13.6% but the 12-month period (including May) almost lost it all. President Wilson spent six months in Europe trying to win the peace.

This "New Congress Barometer" performed rather impressively until the passage of the Twentieth Amendment. Since then its successor, the January Barometer has compiled the best record in odd-numbered years of all other known indicators.

JB versus All

Over the years there has been much debate regarding the efficacy of our January Barometer. Skeptics never relent and we don't rest on our laurels. Disbelievers in the January Barometer continue to point to the fact that we include January's S&P 500 change in the full-year results and that detracts from the January Barometer's predicative power for the rest of the year.

Others attempt to discredit the January Barometer by going further back in time. A certain diligent newsletter watchdog, who does impeccable and thorough research, tested the January Barometer back to 1897. While we respect and appreciate the depth of the research, it fully misses the point and the basis for the January Barometer. (Hosts of others have gone down the same dead end street.) Almanac Investors know there would be no January Barometer without the passage of the twentieth "Lame Duck" Amendment to the constitution in 1933.

After the Lame Duck Amendment was ratified in 1934 it took a few years for the Democrat's heavy congressional margins to even out and for the impact of this tectonic governing shift to take effect. Hence our January Barometer starts in 1938. In light of all this debate and skepticism we have compared the January Barometer results along with the full year results, the following 11 months' results, and the subsequent 12 months' results to all other "Monthly Barometers" using the Dow Jones Industrials, the S&P 500, and the NASDAQ Composite.

Here's what we found going back to 1938. There were only six major errors. In addition to the five major errors mentioned above, in 1946 the market dropped sharply after the Employment Act was passed by Congress, overriding Truman's veto, and Congress authorized $12 billion for the Marshall Plan. Including these six errors, the accuracy ratio is 91.0% for the 67-year period. Including the 7 flat years the ratio is 80.6%-still effective.

For the benefit of the skeptics, the accuracy ratio calculated on the performance of the following 11 months is still solid. Including all errors-major and flat years-the ratio is still a respectable 73.1%.

Now for the even better news: In the 43 up Januarys there were only three major errors for a 93.0% accuracy ratio. These years went on to post 16.6% average full-year gains and 12.1% February-to-December gains.

Now let's compare the January Barometer to all other "Monthly Barometers." For the accompanying table we went back to 1938 for the S&P 500 and the Dow-the year in which the January Barometer came to Life-and back to 1971 for NASDAQ when that index took its current form.

The accuracy ratios listed are based on whether or not the given month's move-up or down-was followed by a move in the same direction for the whole period. For example, in the 67 years of data for the S&P 500 for the January Barometer, 54 years moved in the same direction for 80.6% accuracy. (Maybe Steinbrenner can find a hitter that bats .806.)

The Calendar Year ratio is based on the month's percent change and the whole year's percent change; i.e., we compare December 2003's percent change to the change for 2003 as a whole. By contrast, the 11-month ratio compares the month's move to the move of the following eleven months. February's change is compared to the change from March to January. The 12-month change compares the month's change to the following twelve months. February's change is compared to the change from March to the next February.

Though the January Barometer is based on the S&P 500 we thought it would clear the air to look at the other two major averages as well. You can see for yourself in the following table that no other month comes close to January in forecasting prowess.

There are a few interesting anomalies to point out though. On a calendar year basis the Dow in January is one notch above the S&P. For NASDAQ April sticks out as well on a calendar year basis, but that is after four months have passed. Besides, you want to know how the year might pan out following January, not April. And no other month has any basis for being a barometer. January is loaded with reasons.

Being the first month of the year it is the time when people readjust their portfolios, rethink their outlook for the coming year and try to make a fresh start. There is also an increase in cash that flows into the market in January, making market direction even more important. Then there is all the information Wall Street has to digest: The State of the Union Address, FOMC meetings, fourth-quarter GDP, earnings, and the plethora of other economic and market data. We'll continue to delve deeper into the January Barometer (and other indicators) but for now we are content that its results will refute any representations to the contrary.

Down Januarys Followed by Further Declines

Though some years posted full-year and 11-month gains, every down January since 1938 was followed by a new or continuing bear market or a flat year. Excluding 1956, down Januarys were followed by substantial declines averaging -13.6%, providing excellent buying opportunities in most years.

Down Januarys are harbingers of trouble ahead, in the economic, political, or military arenas. Eisenhower's heart attack in 1955 cast doubt on whether he could run in 1956 - a flat year. The two other election years with down Januarys were also flat. Eleven bear markets began and four continued into second years with poor Januarys. 1968 started down as we were mired in Vietnam, but Johnson's "bombing halt" changed the climate. January 2003 closed down in the face of imminent military action in Iraq, and the market triple-bottomed in March just before U.S. led forces began their blitz to Baghdad. The market put three years of the bear behind it as the fall of Baghdad combined with pre-election and recovery forces to fuel 2003 into a banner year.

(Continues...)

---

Excerpted from The Almanac Investor by Jeffrey A. Hirsch Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

---