No Tradable Signal From January’s First Five Days
Thursday, January 9, 2014
Charles Rotblut, CFA
AAII Journal Editor

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 43.6%, up 0.5 points
  Neutral: 31.4%, up 3.7 points
  Bearish: 25.0%, down 4.3 points

Long-term averages:
  Bullish: 39.0%
  Neutral: 30.5%
  Bearish: 30.5%

Take the AAII Sentiment Survey »

One indicator, the “First Five Days,” suggests the S&P 500’s full-year returns can be determined by how the index performs during the first five days of the year. If the first five days are positive, January’s returns will be positive and the calendar year will end with a 12-month gain. According to the Stock Trader’s Almanac, the last 40 up First Five Days were followed by full-year gains 34 times.

This year, the S&P 500 ended its first five trading days down by 0.59%.

Before you run for the hills, there are a few things worth considering. First, the First Five Days indicator has had “a spotty record” during midterm election years, according to Jeff Hirsch, the editor-in-chief of the Stock Trader’s Almanac. He describes the indicator as almost being “contrary” during such years. Second, Mark Hulbert recently wrote on MarketWatch, “On average, the first five days of every other month have just as much ‘ability’ to foretell the market’s direction over the subsequent 359 days.” Third, while there is a correlation between full-month gains in January and full-calendar-year gains for the market, the January barometer’s performance is much closer to a coin toss when the market is down in January. Fourth, there is a huge difference between a correlation and a causal link. January gains often happen during positive years for the market, but they don’t cause the market to be up for the full year.

There are other indicators offering insight into the potential upside or downside the market may experience this year. Earnings estimates, for example, do not bode well for the bulls. Thomson Reuters tabulates negative earnings preannouncements from 108 members of the S&P 500 and positive preannouncements from just 11. If this negative/positive (N/P) ratio of 9.8 holds, it will be the most negative such ratio since Thompson Reuters started tracking the data in 1995. S&P Capital IQ says their ratio of negative-to-positive guidance is above the 15-year average. Though worrisome, it is possible that fourth-quarter earnings expectations have been lowered so much that many companies will have an easy time surpassing them.

Valuations present a mixed picture. Robert Shiller’s cyclically adjusted price-earnings (CAPE) ratio is at 25.4. The ratio has only been higher in periods around 1929 and 1999. During those time periods, the ratio rose to levels far above where it is now. Thomson Reuters says the S&P 500 is trading at 16.8 times projected 2013 earnings and 15.2 times projected 2014 earnings. Though not cheap, these valuations are not pricey either. On a relative basis, nearly of a third of the approximately 340 S&P 500 companies with both a current and a five-year average price-earnings ratio are trading at valuations below their five-year average. (The relative valuations are based on data in our Stock Investor Pro program.)

As far as what happens following a good year, the data is mixed. According to Sam Stovall at S&P Capital IQ, years with a gain of more than 20% have been followed up by another positive year for the market 78% of the time since 1945. When performance of the previous year is not considered, however, the market has experienced a calendar-year gain 71% of the time.

It’s possible to read the tea leaves as saying one thing or another, but it’s not really clear how this year will turn out. If economic growth is stronger than expected and the politicians don’t do anything to spook Mr. Market, stocks should do well. This forecast assumes traders don’t become too worried about higher interest rates. If growth slows, the outlook could change. The possibility of a currently overlooked or unexpected event affecting the market in either a positive or negative manner always exists.

Though certainty is always welcome, most forecasts tend to be wrong. This is why it is better to understand what the current landscape is and accept the likelihood of an unexpected outcome than to make a big bet based on what you, or someone else, thinks will happen.

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The Week Ahead

Approximately 20 members of the S&P 500 will report earnings next week, mostly mega-cap companies. Included in this group will be Dow components JPMorgan Chase (JPM) on Tuesday; American Express Co. (AXP), Goldman Sachs (GS), Intel Corp. (INTC) and UnitedHealth Group (UNH) on Thursday; and General Electric (GE) on Friday.

The first economic reports of note will be released on Tuesday: December retail sales, December import and export prices and November business inventories. The December Producer Price Index (PPI), the January Empire State Index and the Federal Reserve’s Beige Book will be released on Wednesday. Thursday will feature the December Consumer Price Index, the January Philadelphia Fed Survey, and the December National Association of Home Builders housing index. December housing starts and building permits, November industrial production and capacity utilization, and the preliminary University of Michigan January consumer confidence survey will be released on Friday.

Several Federal Reserve officials will make public appearances. Atlanta president Dennis Lockhart will speak on Monday and Wednesday. Philadelphia president Charles Plosser and Dallas president Richard Fisher will speak on Tuesday. Chicago president Charles Evans will speak on Wednesday. San Francisco president John Williams and outgoing Chairman Ben Bernanke will speak on Thursday.

January stock options will expire on Friday.

AAII Sentiment Survey

The proportion of individual investors expecting a flat market over the next six months is back above 30%, according to the latest AAII Sentiment Survey. This week’s results also show that bullish sentiment remains above average, while pessimism is lower.

Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 0.5 percentage points to 43.6%. The increase keeps optimism above 40% for the 12th time in the past 14 weeks and the 14th in the last 18 weeks. The historical average is 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged, rose 3.7 percentage points to 31.4%. This is the first time in four weeks, and just the second in the past seven weeks, that neutral sentiment is above its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, pulled back by 4.3 percentage points to 25.0%. The decline puts pessimism below its historical average of 30.5% for the 13th consecutive week and the 15th out of the past 17 weeks.

The current streak of above-average optimism is the longest since October 13, 2011, through March 29, 2012, when bullish sentiment was above average for 20 out of 25 weeks. The last time bearish sentiment experienced a consecutive streak of below-average readings was January 5, 2012, through April 5, 2012, when pessimism was below average for 14 consecutive weeks.

Helping to keep bullish sentiment above its historical average are earnings growth, economic growth, the record highs established by the large-cap indexes and the Federal Reserve’s tapering of its bond purchases. Keeping optimism from being higher are worries about the pace of economic growth, elevated stock valuations and frustration with Washington politics.

This week’s special question asked AAII members what factors are most influencing their six-month outlook for stocks. The economy was cited the most, with one-third of respondents listing it. Many respondents thought the job market and/or business conditions are improving, though some thought the pace of expansion is still too slow. Monetary policy and interest rates came in second, listed by 26% of respondents. Many of them pointed to the decision to taper bond purchases. Earnings were third, mentioned by 22% of respondents. Politics were mentioned by 18% of respondents, many of whom expressed frustration over the ongoing partisan battles, the federal debt or current government policies.

» Take the AAII Sentiment Survey