Can three indicators predict the market’s direction in 2018?
The Dow Jones closed the books on 2017 with its longest streak of monthly gains since February of 1959. It set a new record with a 5,000 point gain, dashing the previous record by 1,600 points, on an advance of 24 percent. With such unprecedented upward movement without a significant pullback in 2017, can the market move higher still in 2018? Three specific market indicators appear to be indicating an affirmative answer to this question, but how reliable are these indicators?
The Santa Claus Rally
“If Santa Claus should fail to call, bears may come to Broad and Wall.” So said Yale Hirsch, creator of the annual “Stock Trader’s Almanac,” in 1972 after he noticed what he coined the “Santa Clause Rally.” As he defined, the rally is measured over “the last five trading days of the year plus the first two of the New Year.”
The indicator plays two roles: First, over the last 67 years, the S&P 500 has risen an average of 1.8 percent in that seven-trading-day window. This year, the S&P 500 rose 1.1 percent during this time. Second – and this is where the little ditty comes into play – if those seven days yield a negative return, that is a foreboding omen for overall market performance in the coming year. One of the most plausible explanations for the accuracy of the Santa Claus Rally is that it is caused by people anticipating the other two effects: the First Five Days and the January Barometer.
The First Five Days Indicator and January Barometer
True to their names, the First Five Days (FFD) indicator and the January Barometer (JB) suggest that if the market ends the first five trading days and the first month of the year with a gain, it will close out the year with an overall gain. Proponents of these twin indicators point to the 54 times the Santa Claus Rally has occurred since 1950. Of those times, the FFD and JB indicators were both up 29 times.
How reliable has the First Five Days indicator been? In 2018, a midterm election year, this indicator has a poor record. In the last 17 midterm years, 8 years followed the direction of the FFD indicator and 9 did not.
In 2018, the market rose a significant 2.8 percent in the first five days of trading, which based on the research referenced, has now given us two of three indicators pointing to the expectation for higher markets in 2018.
Will the January Barometer ring in the trifecta?
Having achieved positive returns with the Santa Claus Rally and the First Five Days Indicator, attention is now fully focused on the third market indicator, the January Barometer. If the market remains at current levels and the January Barometer is positive as well, based on these indicators, 2018 could be a banner year for stocks.
In years when each of the three indicators was positive, the full year ended positive 93.1 percent of the time and posted an average annual gain of 17.9 percent.
Should investors pay attention?
Indicators are never without their flaws. For one, the FFD indicator only works in one direction; its accuracy for bear markets is slightly better than 50/50. Second, it only works under a very specific timeline: Extend it back to when the Dow Jones was founded, and it barely gives you an edge.
While the existence of the investment value surrounding the indicators may be as dubious as that of Santa Claus himself, the market is unequivocally off to a strong start. The first week of trading seems to indicate that jolly old St. Nicholas brought some wonderful presents this year in the form of the 2017 Tax Reform package, a US and global resurgence in corporate profits and an increase in investor confidence in the markets.
We believe 2018 has the opportunity to improve on the track record of these indicators, but only time will tell.
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