By Jack Hough
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.
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.