Early Warning Indicators Predict Stock-Market Returns in 2014 …

Early Warning Indicators Predict Stock-Market Returns in 2014 …

The S&P 500 Index of the largest U.S. stocks jumped 29 percent this year, as companies collectively added $3.7 trillion in market value. U.S. stocks beat almost all rivals around the world, in most cases by a wide margin.

And stocks outperformed bonds more than at any time in history, according to Bloomberg market data. So the question on every investor’s mind is: What’s in store for 2014 … will stocks have a repeat performance?

To help answer that question, beginning today, investors should pay close attention to an “early warning” indicator that has been correct 85 percent of the time at forecasting the stock market’s direction for the full year.

It’s worth paying attention to the stock market’s trend over the first five days of 2014.

First, before making projections about the year ahead, let’s take a look at how the current Santa Claus Rally is faring. As defined by the folks at the Stock Trader’s Almanac, this is the seasonal tendency for stocks to rise during the last five trading days of December, continuing into the first two trading days of the New Year.

Since 1950, the S&P 500 has averaged a gain of 1.5 percent during the typical seven-day seasonal uptrend, but the Santa Claus rally is most conspicuous when it is absent. In other words, if stocks fail to rally during the holiday season, it often foreshadows a difficult year ahead for the stock market, if not the start of an outright bear market.

Let’s take a closer look at the numbers.

* Last year’s Santa Claus Rally was merry, with the S&P 500 gaining 2 percent during the seasonal sweet spot and, sure enough, stocks went on to post spectacular gains in 2013.

* But in December 1999-January 2000, a 4 percent Santa Claus slump correctly foreshadowed a 10.1 percent decline in 2000 and the start of a bear market that persisted until October 2002.

* And a 2.5 percent loss in December 2007-January 2008 occurred on the eve of the subprime financial crisis and the second-worst bear market in history.

Results won’t be official until tomorrow’s close. So keep your fingers crossed for more gains today and tomorrow!

Still, there have been some bad years for the stock market, even following strong Santa Claus rallies.

Typically, an uptrend in stocks over the first five trading days of the New Year leads to more gains in the year ahead. Stock Trader’s Almanac crunched the numbers going back to 1950 and found that over the past 41 years when stocks rose during the first five days of the year, the S&P 500 went on to post full-year gains 35 times. That’s an 85.3 percent batting average for accuracy!

In recent years this early warning indicator has served investors well. Since 2000, stocks began the year on the downside five times (2000, 2001, 2005, 2007 and 2008). And the average return for the S&P 500 during those five years was minus 11 percent.

In fact, a poor start to the year was followed by full-year losses in three out of five years, including a 38.5 percent drop in 2008. And in the two other years, very small gains averaging just 3.2 percent followed early declines in 2005 and 2007. In 2002, stocks posted gains of 1.1 percent during the first five trading days, but the S&P 500 still went on to lose 23.4 percent that year.

No indicator is perfect, but when stocks are down the first five days in January, the market manages to rebound for full-year gains only a little more than half the time, and stocks have suffered spectacular losses some years.

So it’s worth paying attention to the stock market’s trend over the first five days of 2014, which runs through the close on Wednesday, Jan. 8, but even if stocks head south right out of the gate, it’s no reason to throw in the towel on the entire year — not yet, anyway. The so-called January Barometer, based on the trend in stocks over the first full month of the year, has an even longer and stronger track record at predicting the course stocks could take this year. Stay tuned.

Happy New Year and Good Investing,

Mike Burnick

Mike Burnick, who has over 25 years of professional investment experience, oversees the Wealth & Liberty Alert newsletter with Charles Goyette and is a contributor to the daily newsletter Money and Markets.

Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also held the position of investment research analyst and Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.

The investment strategy and opinions expressed in this article are those of the author and do not necessarily reflect those of any other editor at Weiss Research or the company as a whole.

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