Alpha Power Investing Newsletter

February 7, 2013

January Omens

Last year, about this time, I wrote about the predictive power of market action in the month of January. The news was good then and it's good now.

About 30 years ago, Yale Hirsch (of Stock Traders Almanac fame) discovered that market action during the month of January was a strong predictor of the full year's returns. Up Januarys strongly predicted a gain for the market over the full year.

Since 1950, the S&P 500 has had 39 up Januarys resulting in 35 full-year gains - a 90% predictive value. When January is very strong (above 4% gain), which has occurred 19 times, the predictive value rises to 100%. This January the S&P 500 rose about 5%, making it the tenth strongest on record since 1950.

Better yet, both the opening week and the closing week were up, adding to the predictive value. Since 1937, there have been 24 occasions when the first week, last week, and full month of January were all up. The remaining part of the year (February - December) was up 92% of the time (22 out of 24), averaging a 13.3% return.

Another important event occurred in the first week of January - the Russell 2000 small-cap index set an all-time new high. This index, which measures more speculative, leveraged companies, led the Dow and the S&P 500. Bull markets are almost always characterized by small-cap leadership. When investors are bullish, they gravitate to stock issues which are speculative and volatile.

Clearly investors' "animal spirits" are aroused. Under the circumstances, it will take a powerful jolt of bad news to turn their psychology around.

Stocks are expensive today, not cheap. The Shiller PE ratio stands at 23.1x, in the top decile of historical valuation. This is nose bleed territory, practically identical with the level of over-evaluation of 1929 and 1968 - two occasions which preceded lengthy and damaging long-term bear markets.

The Fed is propping up the market with the prospect of ultra-low interest rates forever. But this game will change, and when it does, investors will clamor for the exits like a panicked herd of buffalo. It is quite likely that 50% - 100% of the gains since 2009 will be lost.

Long-term investors should realize that the market is not random. There are predictable long-term patterns in the distribution of market returns over time. One of the most reliable of these is the tendency of stock markets globally to concentrate long-term returns into the six-to-seven month period beginning in late-October. Since 1949, between the end of October and the end of April, the Dow Industrials have had an average daily rate of appreciation that is 27 times greater than the average daily appreciation the rest of the year. This is not a statistical accident. It is caused by human nature, which is the same everywhere.

Briefly, here is what happens. Toward year-end, investors look ahead to the next calendar year. They seek information from the "experts" - the army of earnings analysts and other pundits provided by Wall Street and its minions. These "forecasters" tend to be overly optimistic due to inherent conflicts of interest and the innate tendency of human beings to put a positive spin on events. This optimism lifts investors' "animal spirits" late in the year and early into the following year. As time passes and reality begins to emerge, optimism frequently gives way to a more sober view of the market as the "experts" begin to downgrade their earlier estimates.

Since 1949, the Dow Industrial Average has been up 55% of the time between April and November with an average annual rate of appreciation of -0.5%. More to the point, about 80% of bear market damage has occurred during this six-month period which I call the "dead zone".

During periods of high valuations, such as exist today, dead zone declines tend to be particularly damaging and may extend over multiple years, such as occurred in the three-year period beginning in 2000 to the end of 2002. The best case scenario is that the market will back-and-fill over many years, while earnings go up and stocks get back to "normal" or "cheap" valuations.

This back-and-fill has been going on since late 1999. The S&P 500 is still below its early 2000 high point. Mid-cap stocks, on the other hand, have doubled over the same period. To see how this universe of stocks performs during the late-October to late-May "power zone", visit the Programs and Performance section of our website at www.alphaim.net and click on the Alpha Mid-Cap Power Index Managed Account brochure link. In the brochure you will find the complete history of the S&P MidCap 400 Index during both the "power zone" and the "dead zone", as well as the performance of our program.

Sincerely yours,
Jerry Minton, Ph.D.
President
1-877-229-9400, Ext. 11

Past performance is not a guarantee of future performance.

 
© 2013 Alpha Investment Management, Inc.
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