January Barometer predicts tough year for stocks
A reliable historical indicator says 2010 will be negative for the market.
A number of technical measures suggest we're rapidly nearing a short-term turnaround for stocks. Market breadth has fallen to extreme lows. After the close on Friday, a little more than 10% of stocks were over their 10-day moving average -- a level that has been reached only a handful of times over the past year. The S&P 500 also violated its 18-week moving average, a level that offered support last year and hasn't been breached since summer 2008.
I continue to see lots of parallels to what happened back in 2004 -- which was the last time the economy was recovering and the Federal Reserve was preparing to tighten policy. Back in March of '04, there was a short sell-off that took the S&P 500 down beneath its 18-week moving average for two weeks. That was followed by two deeper plunges of 6 weeks and 7 weeks in length.
So the takeaway here is that we should prepare for a short rebound rally. After that, expect another correction or two that will be deeper and longer lasting than the current one. And in the end, stocks in general will likely finish in negative territory for the year because of the bearish January Barometer -- which was triggered by a negative return last month . Here's why.
January's stock market return has a special history of being able to predict the entire year's return. Excluding years in which the S&P 500's annual return was between 5% and -5% -- so ignoring flat years -- January's monthly return has been an accurate predictor of the full year's return more than 70% of the time since 1791. The indicator has become more powerful recently, with accuracy increasing to 89% since 1938.
Jeffrey and Yale Hirsch of the Stock Trader's Almanac originally discovered this predictor in the 1970s using data from 1950 onward. I conducted my own analysis going all the way back to 1791 for your benefit. While by no means a guarantee, the January effect does suggest that 2010 will likely finish at a lower level than it started.
I know this may be a somewhat unpleasant outlook compared with the awesome ride stocks have enjoyed since March. But knowing that an extra measure of nimbleness will be needed this year puts us one step ahead of the crowd on Wall Street.
Disclosure: The author does not own or control a position in any of the funds or companies mentioned. You can watch him trade during the day at Wall Street Survivor here.
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