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Go Ahead, Follow the ‘Five Days Rule’

Monday is the fifth trading day of the year. The S&P 500 index at midday was 1.8% higher for the year.

Those two facts should delight neurotic investors.  As Jim O’Neill, chairman of Goldman Sachs Asset Management, pointed out in a client note over the weekend, when the S&P rises in its first five days of the year, it tends to have a good year.

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The success rate is 87% going back to 1950, writes O’Neill, citing data from the “Stock Market Almanac” (Stock Trader’s Almanac, he likely means).  For years when the first five days are negative, there’s no clear trend, writes O’Neill.

Like a well-written fortune cookie message, the so-called First Five Days Rule does little harm and seems meaningful.  But it’s a novelty, not a guide.

The stock market has an upward bias over the long term, because over time, economies generally grow and inflation raises asset prices.  In the short term, however, market movements are unpredictable enough to be considered random.  It’s human nature to see simple patterns in sequences of random events, and to believe those patterns hold meaning.  That’s what keeps roulette tables running.  But the outcome of one week of stock trading doesn’t predict that of another with any reliable success.

The exception, of course, is when we include the first week of trading in the total results.  Week one has nothing to do with Week two, but it makes up half of the return of Weeks one through two.  So yes, the First Five Days Rule does a fine job of predicting returns for the year, but it’s not predicting at all.  It’s making a probability judgment based on known results.

The so-called January Barometer, which uses the first month of results to predict whether the full year will be a good one, is unsurprisingly more accurate than the First Five Days Rule.

(Don’t confuse the January Barometer with the January Effect.  In the latter, stocks that sink one year tend to do well in the first several days of the following year.  That effect seems rooted in human behavior; one theory holds that investors tend to wait too late in the year to sell for tax purposes, unduly depressing the prices of certain stocks at the last minute, and leaving them poised for a rebound.)

The decent start to 2012 trading is just that: a decent start.  It does no good for the investor who buys on Tuesday.  But then, for long-term investors, stocks seem a better place to be than cash (see “Don’t Spend 2012 Hiding in Cash”), and U.S. stocks, which the S&P 500 tracks, compare well against those of other markets (see “Why U.S. Stocks Could Outperform in 2012”).  So go ahead and follow superstition.


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    • Place Your Bets – January 09, 2012

      by Slipposlappo

      When 50 Day Simple Moving Averages cross 200 Day Simple Moving Averages, it is a big deal. Many large ships change their courses when this happens. The SP500 Index is the most accurate as it is the most diversified and accounts for share price as well as market cap in its weighting, but the Dow Jones Industrial Average is also very important as many mutual funds track this as well. If you take note, the Dow Jones Industrial Average’s 50 Day Simple Moving Average has just crossed its 200 Day Simple Moving Average. Maybe one more down leg on the SP500 Index with resistance at its 50 Day Simple Moving Average and the SP500 Index will stay above its 200 Day Simple Moving Average. Bears may easily point to the Nasdaq Index as a leading indicator reflecting a type of stalling 2012 may hold, and that may well be the case, but given the likes of Facebook and other IPOs to spur interest in that index, I forsee sharper gains in that index than any others. Just pointing out, while you may not care about the crossing of moving averages, many other people and technical traders do care. Especially as gold is amidst a bearish period, and bond yields are only fairly priced if you predict for the world economy to be stagnant over the next 30 years, the stock elevator, at least regarding the ill-designed, but oft tracked Dow Jones Industrial Average, is going up.

      My takeaway is this:

      1) Stocks prices are going up in a sustained manner until at least the summer of 2012

      2) As you realize gains between now and summer, if you require liquidity, would like to protect gains, or would like to re-allocate funds, I would dollar-cost sell existing positions (sell fixed amounts each month for varying gains) between now and May 2012 and hold the cash for a potential stock buying spree in a possible market downturn in the summer of 2012 (based on the historical seasonality of stocks)

      3) If the market downturn does not occur in the summer of 2012, then the case for stocks increasing in value is even larger because starting in November 2012, the newly elected/re-elected US President and US Congress will have an ease of passing bills associated with their parties that promote stimulus in their own ways. The bottom line is that neither party will choose to not stimulate the economy, they just have different ways of doing it.

      Using my crystal ball, remember how China was an island of economic prosperity while the whole rest of the world took a s#$% in 2007-10? I believe the US will do this over the next few years as Europe enters a recession from strict monetary contraction (America learned this in the Great Depression) and industrial exporter China is forced to slow down or else face crippling inflation (America learned this in the 70′s).

      Longer term, energy independence, natural gas, and gasoline exportation will be the windfall that will allow America to pass the gall stone that is the baby boomers.

      Hope this provides some clear guidance, not that anyone was asking for it.

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