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By William Patalon III
And Jennifer Yousfi
Money Morning Editors
Bad January. Bad Year.
And now that January 2008 is in the books, it's official: January was a losing month for the Standard & Poor's 500 Index.
And if a longtime market axiom is true to form, it's going to be a rough year for the S&P 500 and U.S. stock prices.
Most investors have heard of the so-called "January Effect,' the theory that the stocks sell off in late December, and then post healthy gains in the first week or so of the New Year. As it became better and better known, professional investors largely neutralized this trading manifestation, and it's become hit or miss whether the January Effect will play out in a given year.
But the so-called "January Barometer Theory' is a much-different story.
"As goes January, so goes the rest of the year,' is a trusted investing axiom that has been around since the early 70s. Yale Hirsch, inaugural editor of The Stock Trader's Almanac, was the creator of the January Barometer Theory, which states January's S&P 500 performance is an indicator of how the index will perform for the rest of the year.
When stocks do well in January – as they did in 2007 – investors are quick to embrace the theory and its virtues.
But when the New Year gets off to a dismal start – as has been the case this year – investors are quick to disavow the theory, and to hope that this adds to the very small group of years that have managed to go against the January Barometer Theory.
Unfortunately, it's not easy to ignore the evidence.
You see, there have been only five times since 1950 when the theory didn't accurately predict the full-year performance for the broadest of the three major U.S. stock indices. The exceptions to the rule occurred in 1966, 1968, 1982, 2001 and 2003.
According to the theory, if the S&P 500 posts a gain in January, the index will go on to post a gain for the year. However, if the index posts a loss in January, then it will post a loss for the full year.
How accurate is this virtual crystal ball?
According to Hirsch's research, January's performance predicts the stock-price trend for the rest of the year about nine times out of 10. If you toss out a few "close calls,' when the market was relatively flat – up or down less than 5% for the year – then the predictor is still on target about 75% of the time.
So how did the S&P fare in January?
After the Dow Jones Industrial Average lost 200 points or more in two of the first three trading days of the New Year – the worst start since 1904 – the S&P has been whipsawed to a 6.12% decline for the month.
And even with a 1.68% gain that capped off the month in positive fashion yesterday (Thursday), the S&P remains down nearly 12% from its October 2007 peak. [For a related story on yesterday's stock-market action, please click here].
But it's not necessarily fait accompli: A handful of years have gone on to see positive results after a down January and they were all Presidential election years.
As is 2008.
And the U.S. Federal Reserve certainly seems to be heeding the January Barometer warning. Led by Fed Chairman Ben S. Bernanke, central bank policymakers slashed short-term interest rates by another half a percentage point on Wednesday, bringing the key Federal Funds Rate down to 3.00% — below expected inflation levels for the year.
This fifth rate-reduction action since summer came just eight days after the Fed's surprise 75 basis point cut on Jan. 22.
"This is an all-out, no-recession policy with little concern about the inflation consequences,' Robert Eisenbeis, former research director at the Atlanta Fed, told Bloomberg News. "The focus is on financial markets and credit disruptions.'
But some experts wonder if the Fed is focusing on the right issue, by giving the markets what they want.
"This Fed hasn't shown the willingness to disappoint financial markets and the expectations of rate cuts,' John Ryding, chief U.S. economist at The Bear Stearns Cos. Inc. (BSC) in New York, said in an interview with Bloomberg Television. "We are going to be headed towards more significant inflation problems.'
Money Morning Contributing Editor Martin O. Hutchinson agrees. He believes the market has been over-valued for years and will continue to fall this year, which means he feels the January Barometer reading is correct for 2008.
"Trends in the market are rather persistent – longer than you would expect for a random walk,' Hutchinson said in a telephone interview yesterday. "Trends don't turn on a dime, so it makes sense that a down January would carry through to the next several months.'
Keith Fitz-Gerald, Money Morning Investment Director, notes the many factors at play that are on the minds of the Fed and investors alike.
"While the so-called January Barometer has statistical validity, there's a lot of countermanding influences at work right now,' Fitz-Gerald said. "The Fed is monetizing debt as fast as it can and there is a tsunami of cash headed into the United States right now, which could cause a rally in and of itself.'
Added Fitz-Gerald: "I'd be hesitant making a directional bet on the January effect alone.'
Indeed, forewarned is forearmed, Fitz-Gerald believes. And that calls for a "safety-first' defensive portfolio that provides a downside defense in a bearish market, but that is positioned to also generate solid returns should bullish conditions return.
"Barring upbeat economic data, none of the issues that the Fed referenced in its most recent statement are going to go away any time soon,' Fitz-Gerald said. "Not only does this make the case for remaining global when it comes to investor allocations, but it strongly reinforces the need for a thick layer of financial armor.'
Key areas to consider:
- Financials and homebuilders are the obvious casualties, and generally are too risky to dabble with right now.
- Natural-resources, energy and shorter-term bond holdings are sound plays.
- Dependable dividend income is critical. The Alpine Dynamic Dividend Fund ( ) is an excellent choice.
- And an old fashioned-balanced fund isn't "boring' right now – it's shrewd. One of Fitz-Gerald's favorites is the Vanguard Wellington fund (VWELX).
"This is not an all-or-nothing game,' Fitz-Gerald says. "It is absolutely possible to preserve upside without dismantling your portfolio … for more conservative investors, there's nothing better than a plain old fashioned balanced fund.'
Related News & Links:
- The Kansas City Star:
- Bloomberg News:
Bernanke's Rate Cut, Outlook Align Fed With Investors
- Money Morning:
January Effect Chills Investors with Gloomy 2008 Outlook
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.