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John Prestbo's Indexed Investor
Feb. 4, 2010, 12:01 a.m. EST · Recommend · Post:
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By John Prestbo
NEW YORK (MarketWatch) -- If January is supposed to indicate the stock market's performance for the whole year, it is time to get a second opinion.
The "January indicator" is the tendency of stock-market movement in the first month to signal the trend for the entire year. If a market average is higher at the end of January than it is at the beginning, this indicator suggests that the market will be up for the calendar year.
The market's decline in January is raising some alarm about what it signal's for the year. But the historical record is more ambiguous than ominous. Barron's Mike Santoli reports.
We examine this maxim with the uncomfortable knowledge that the market fell in January. The Dow Jones Industrial Average /quotes/comstock/10w!i:dji/delayed (INDU 10,271, -26.30, -0.26%) closed on Jan. 31 at 10,067, down 3.46% from 10,428 on Dec. 31, 2009. To be sure, the Dow posted a 15-month closing high on Jan. 19 of 10,725, but since then has sunk 6.14%. Will the market follow suit for the rest of 2010?
Nobody knows, of course. There is some solace in recent experience, however: The Dow dropped 8.8% in January 2009 in the midst of the Great Meltdown. But it ended the year 18.8% higher. In 2001, on the other hand, the Dow gained 0.9% in January and went on to lose 7.1% in the full year.
To see how history shakes out on this question, we pulled data back to the end of World War II. In those 65 years, the Dow closed higher 45 times and lower 20 times. There were 43 positive Januarys, though, and 22 negative ones.
That's hardly a slam-dunk case for January predicting the full-year Dow. There actually were 12 years -- 18.5% of the total -- in which the direction of the Dow in January did not match that of the full year. Of those, seven were incidents in which January was negative but the year was positive, and five in which January was positive while the year was negative.
The biggest negative-to-positive leap occurred in 2003. The Dow fell 3.5% in January but closed the year with a 25.3% gain, moving the needle by 28.8 percentage points. Last year's 8.8% drop was the largest January decline in the post-war period. The full-year gain of 18.8% produced a negative-to-positive sweep of 27.7 percentage points.
In the 38 years where a positive January was followed by a positive full year, the average January gain was 3.9% and the average full-year advance was 17.2%. In the 15 years where a negative January was followed by a negative full year, the average January decline was 3.9% and the average full-year drop was 10% (which was fattened by 2008's 33.8% plunge, the largest calendar-year fall in the post-war period).
But in the seven years where a negative January was followed by a positive full year, the average January decline was 4.1% and the average full-year increase was 13%.
Bottom line: The direction of the Dow in January foretells the direction for the full year about 80% of the time. But most of that historical tendency comes in up markets. Focusing just on negative Januarys like this one, roughly one out of three times in the past a positive year materialized despite the first-month decline.
On a separate but related matter, the Dow's 3.5% drop was less than the Standard & Poor's 500-stock index's 3.7% retreat. This performance squares with historical experience of the Dow usually doing better than the S&P 500 /quotes/comstock/21z!i1:in\x (SPX 1,097, -6.04, -0.55%) in falling markets, with the reverse being the tendency in rising markets.
January therefore marks a reversal of last year's results, in which the S&P 500 (ahead by 23.5%) bested the Dow (up 18.8%).
The main factor contributing to this performance difference is that the S&P 500 includes some mid-sized and small-cap stocks, which are more volatile generally and consequently more vulnerable in downturns.
Last year, the S&P 500's bottom two quintiles of market capitalization -- amounting to 424 companies at year-end -- together contributed 11.5 percentage points to the index's results, or almost half. By contrast, the top two quintiles -- fewer than 20 companies, including half of the Dow's components -- contributed 7.6 percentage points.
In January, the top two and bottom two quintiles were more evenly matched, together accounting for all but 0.6 percentage point of the S&P 500's decline. The top tier's contribution indicates another factor in differing performances: The Dow is price-weighted and the S&P 500 is market-cap weighted, which means the same stocks in some instances have much-different weights in the two indexes.
For example, Boeing Co. /quotes/comstock/13*!ba/quotes/nls/ba (BA 61.46, -0.06, -0.10%) weighs 4.5% of the Dow but 0.4% of the S&P 500. As a result, the stock's 12% rise in January contributed 0.47 percentage point to the Dow's performance but only 0.04 point to that of the S&P 500.
It also works the other way. General Electric Co. /quotes/comstock/13*!ge/quotes/nls/ge (GE 16.68, -0.17, -1.01%) rose 6.3% last month, contributing 0.1 percentage point to the S&P 500's performance and 0.07 point to the Dow's. GE totals 1.8% of the S&P 500 and 1.2% of the Dow.
Among market sectors, Technology did the worst in January, slicing 1.3 percentage points off the Dow and 1.6 point from the S&P 500. The only gainer for the month was Health Care, which added 0.04 point to the Dow and 0.06 point to the S&P 500.
How these two indexes relate to one another for the remainder of the year depends on the overall direction of the market and whether large stocks regain favor at the expense of small stocks.
John Prestbo is editor and executive director of Dow Jones Indexes, a unit of Dow Jones & Co., Inc., publisher of MarketWatch. Clifton Dy, Radhika Uppalapati and Ross Wiedman contributed research to this report.
- placebo | 12:52 a.m. Today12:52 a.m. Feb. 4, 2010
It's hard to find much to complain about in Cisco Systems Inc.'s fiscal second quarter or the bullish forecast coming from its ebullient chief executive, except to note that perhaps its stock is looking cheap these days.
5:25 p.m. Feb. 3, 2010 | Comments: 16
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