Editor's Note: This is the Fourth Installment of an Ongoing Series Highlighting Global Investing Opportunities For 2008.
As 2007 winds down, many investors are scratching their heads about what the New Year might bring in the financial markets.
But those investors should keep in mind three factors that could point to a potentially positive year for stocks in 2008. Key among those factors:
- The New Year is a presidential election year – periods that traditionally are very good for stock prices: In the past 25 presidential-election years, the Dow Jones Industrial Average has increased 17 times – or 68% of the time.
- When stocks post a positive return in the year before the presidential-election year – as they have so far in 2007 – the market gains recorded during the subsequent election year are even higher, studies show.
- U.S. Federal Reserve policymakers – having slashed interest rates three times since mid-September – are expected to reduce rates even further, providing yet another catalyst for higher share prices.
And don't forget to track the stock market's performance in January: Since 1950, in a manifestation known as the January Barometer Effect, research shows that in years where stocks posted positive gains for January, they went on to post a gain for the full year 91% of the time.
While many of the major equity indexes will end the year in positive territory, the overall market performances have been related more to specific sectors or capitalization classes – meaning an investor's portfolio allocations have been the key to determining whether they've succeeded or failed this year.
- Energy stocks have benefited from the significant escalation in oil prices during the year [For our latest investment-research report on oil prices – part of Money Morning's ongoing "Outlook 2008" series that's previewing the top investments for the New Year – please click here. The report is free of charge].
- Financial-services stocks have mostly plummeted as the housing bubble implodes and the credit crisis expands with each passing day. That's opened the door for foreign-controlled sovereign wealth funds to take big stakes in such industry stalwarts as Citigroup Inc. (C), Merrill Lynch & Co. Inc. (MER) and Morgan Stanely (MS) – in some cases at bargain-basement prices.
- Techs have enjoyed strong demand as businesses upgrade their computer systems and communications networks – and consumers seek out the "latest-and-greatest" in entertainment and productivity devices.
- Housing continues to struggle as the subprime-mortgage debacle has effectively blunted the much-anticipated economic rebound.
- Given that the holiday-shopping season just concluded – meaning that a complete analysis of retail sales is not yet available – the jury is still out on the retail sector. The holiday retail season is no small consideration, given that this period can account for as much as 60% of a retailer's sales for the entire year. And since consumer spending accounts for two-thirds of U.S. economic actvity, retail-sales figures are always closely watched.
- Large-caps typically outperform their small-cap counterparts during periods of unease and uncertainty, and this year has been no exception: The Russell 2000 Index has lagged indices of larger stocks this year.
The Year to Come
Looking ahead, many investors are taking their cues from the actions of the U.S. Federal Reserve as they try to predict how the U.S. economy and central bank policymaking decisions will affect their portfolios.
While Federal Reserve Chairman Ben S. Bernanke and members of the policymaking Federal Open Market Committee (FOMC) have slashed the benchmark U.S. Federal Funds Rate at three consecutive FOMC meetings – half a point at the first meeting and a quarter-percentage point at each of the last two – many investors were disappointed the last rate reduction wasn't much larger.
Almost on cue, Bernanke moved to regain investor trust by announcing a joint liquidity-enhancement effort in conjunction with the central banks of England, Canada and Switzerland.
News of the liquidity-infusion plan came only days after U.S. President George Bush unveiled a controversial plan to freeze rates on certain adjustable-rate subprime mortgage loans, a move his administration hopes will "bail out" many ailing borrowers.
While the analyses of monetary policy and of company fundamentals often serve as the primary forecasters of future stock-market activity, some investors choose to look at a few other predictors – and may not have to wait long for answers.
You see, as the month of December yields to the New Year, the time-tested January Effect and January Barometer Effect may start to creep into the discussions [and trading patterns] of certain investors, traders, and market-watchers alike.
TGIJ: Thank Goodness it's January – Almost
The theory of the January Effect basically holds that stocks often rise during the first five trading days of the New Year. After all, many investors engage in tax-loss selling strategies in late December, and also do some "window-dressing" at the end of the calendar year.
Others may need to raise excess cash to cover expenditures made during the holiday season. Since this activity has little to nothing to do with company fundamentals, "savvy" investors are expected to swoop in to find mis-priced opportunities in the market, and to take advantage of them during the first few days of the New Year. Some prognosticators even claim that the year's first five trading days set the tone for the rest of the year.
Indeed, since 1970, when the broad-based Standard & Poor's 500 Index posts an agggregate increase for those first five trading days of January, that broad bellwether has then gone on to notch a full-year gain in 31 out of the 37 years – or 84% of the time.
The January Effect theory began getting more publicity and gaining traction with the advent of 24-hour business news networks, financial blogs, pundits and talking heads sharing more market insight than most investors can possibly digest. As a result, investors increasingly tried to anticipate those January gains by making their investment moves in late December.
The upshot: In recent years, we've watched as the January Effect has given way to the Santa Claus Rally, as bargain hunters often emerge during the last few trading days of the year, intent on getting a jump on those early market timers. In other words, the rally that once took place during those first five trading days of January have been pushed back into late December.
The January Barometer Effect takes this theory one step [or about three weeks] further and states that "As January goes, so goes the year." Noted market historian Yale Hirsch came up with the expression and his Stock Trader's Almanac has revealed its value over an extended time frame. Prior to this year, since 1950, the S&P 500 has posted a gain for the year 91% of the time that the index experienced a positive January. For those "cautious" investors who desire an even larger sampling, since 1926, that percentage [a positive January foreshadowing a positive full year] falls to 80%, although that's still a pretty telling predictor of future market activity.
Every Vote Counts
Looking beyond January, 2008 also brings a presidential election, an event that often has some interesting implications for the stock market. While some politically-minded investors may spend hours debating whether a Republican or Democrat in the White House would be the best for Wall Street, the truth is that the party of the ultimate victor doesn't mean a whole lot in the actual election year.
According to the Presidential Election Cycle Theory, in the past 25 presidential-election years, the 30-stock bellwether Dow has posted a positive annual return 17 times – or 68% of the time. [A positive market performance in the "pre-election" – or presidential-campaign – year results in an even-higher-percentage return in the presidential election year that follows, and 2007 looks to be right on target for another gain in the Dow].
The justification for such performance goes as follows:
- During presidential-campaign years, the party in power does everything possible to provide some form of economic stimulus in order to keep the party in the White House – whether it's the incumbent president, or to install the top candidate of the presidential party as a White House successor. The aforementioned Bush Administration subprime-mortgage-bailout plan is an example for one such proposal offered to stem the tide of recent negativity and economic concern. [For our investment-research report on what the Democratic presidential candidates will mean for investor profits – the first installment of a two-part series – please click here. The report is free of charge].
- Conversely, the opposition party jumps on virtually every mishap that has occurred during the past three years and offers ways that they would be able to manage the economy in a more productive manner. "It's the economy, stupid," was a catchphrase popularized during Bill Clinton's first campaign against President George H.W. Bush, who was shackled with a recession in 1992 – only a year after his positive stewardship of the U.S.-led victory in the Persian Gulf War had given him the highest presidential-approval rating in U.S.history. But given the choice between nationalistic pride and their wallets, investors will vote their wallets. Clinton emerged victorious and – from the stock market's perspective – proved to be a very strong president. If history is on Wall Street's side, 2008 should prove to be another good year for the markets. [Let's hope January cooperates, as well].
Money Morning's "Outlook 2008" Series Last Covered China. Next Up: The U.S. Economy.
Ron Brounes, CPA, is a technical financial writer and president of Brounes & Associates (www.ronbrounes.com), a Houston, Tex.-based consulting firm that provides writing, communications and educational services for financial services professionals. A regular contributor to Money Morning, he last wrote about holiday shopping sales.
News and Related Story Links:
- Money Morning Special Investment Report:
Outlook 2008: How to Profit When Oil Bubbles Up Above the $100 Level.
- Money Morning Investment Research Report:
Citigroup: Why This Turnaround Play Has Legs – Big Ones.
The Santa Claus Rally.
- Money Morning Investment Analysis:
Why Some of the World's Savviest Investors Are Buying – Gasp! – Citigroup.
The January Effect.
- Money Morning Special Investment Report:
Outlook 2008: Eight Ways to Pocket Profits From China, While Dodging the Biggest Risks.
- Business Week:
January Barometer Video.
- Money Morning News:
The Verdict is in: A Quarter Point Cut for the Fed Funds Rate.
The Persian Gulf War.
The January Barometer Effect.
- Money Morning Commentary:
Housing Plan No Panacea for What Ails the U.S. Housing Sector.
The Presidential Election Cycle Theory.
- Money Morning Investment Research Report:
Election 2008: Which Democratic Candidates Will Be Best For Investor Profits.
- Science News Online:
- Money Morning News:
Fed-Led Global Intervention Gives Investors New Hope the Day After Rate Cut Disappointment.