Can You Trust The "January Effect?"

The information below comes courtesy of www.etfguide.com, Technical Forecast (TF) email to WFG, January 2, 2011.

According to the Stock Trader’s Almanac, the January barometer has a 90% accuracy ratio since 1950. The premise of the January Barometer is simple: As January goes, so goes the year.

The December 19 TF featured charts of the S&P’s performance in January 2007, 2008 and 2009, all of which were down months. However, over the past three years a new pattern has emerged. Year-end euphoria has culminated into sentiment extremes and January sell-offs.

• Therefore, the January barometer has proved correct only five times over the past decade, a 50% accuracy ratio.

January 2001 was an up month, but the year ended down. January 2003 and 2005 were down months, but the years ended up. And of course, January 2009 and 2010 were down 8.6% and 3.7% but finished the year strong with returns of 23.5% and 12.6%.

As discussed over the past several weeks, sentiment extremes point towards a January correction and a down month. A down January, however, would contradict another high probability seasonality, the Presidential Election Year Cycle, for example. A pre-election year, such as 2011, sports the best historical performance of the four-year cycle. In fact, the last pre-election year loss was recorded in 1939 (Dow down 2.9%). The last significant pre-election year loss occurred in 1931, during the Great Depression.

The pre-election year performance pop is credited to each administration's efforts to pump up the economy (or at least the stock market) to finish strong and persuade voters to re-elect whoever is in office.

• However, this time around much money has been pumped into the economy before the pre-election year (bailouts, low interest rates, QE1 and QE2). There is a chance that this premature shot of liquidity alters the cycle and mortgaged the market’s otherwise rosy future.

Investing Lesson
Past performance has proven to be a unreliable indicator of future results!