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Jim O’Neill, the Chairman of Goldman Sachs Asset Management, is out with his latest note to clients. As usual, O’Neill discusses the mountain of global economic data we got in the past week. Regarding the financial markets, he points out a potential break in the correlation between the dollar and euro, and he also discusses some new research findings regarding the correlation between the first five trading days of the year and S&P 500’s performance for the full year.
From his note:
So What About Markets?
There are two things which are potentially quite interesting about the markets, but we will need more evidence. In addition to the S&P 5-day rule (more below), there is some extremely tentative evidence that this weird risk on/risk off correlation between the Dollar and US economic news could be changing. The prevailing pattern since 2008 where the Dollar drops on better-than-expected US economic news and rises on disappointing news certainly didn’t pan out last week. If this is the start of the renewal of the more normal historic trend, this would be a fabulous development in my view, as it should make investment decisions more logical, if not easier.
As far as the 5-day rule I discussed as important for me at least, Monday’s close in New York will be the 5th day. After 4 days, the S&P closed up by 1.6 pct year-to-date, but given the fun and games since last Summer, this is easily reversible in a day.
I have found myself quite engrossed in analysis, discussion and debate about this somewhat odd rule in recent days, not least of which because Jose Ursua from the GS Economics, Commodities and Strategy (ECS) department devoted a daily commentary to the topic on Thursday, and subsequently explored it further at my prompting, as have a number of other poor souls including James Wrisdale, and another colleague from GSAM, Rob Hinch.
I first came across this notion from the Stock Market Almanac, and my 2012 edition has been more heavily turned over in the past couple of days than it normally would. It taught be two things many years ago. One, that there is remarkable pattern historically that many major stock markets show very strong performance from November through April, and quite often, quite weak performance from May through October (hence the “sell in May” oft discussed notion). Any investor that stuck to this calendar investing pattern would dramatically boost his returns. And two, when the S&P rises after the first 5 trading days of a new year, the market has a pretty good annual performance. In fact, the Almanac claims the success rate has been just under 87 pct since 1950. Jose studied a broader 5-day rule as well as the “January month” rule in his daily and showed that, for a number of markets, the January factors seemed to be quite powerful, albeit less than I had believed, and not enough to dismiss the superior importance of fundamental analysis.
While I certainly concur with the latter, in fact, the Almanac observation appears to be very strong on additional analysis; it is not useful when the 1st 5 days show a decline. Historically, this appears to offer no concrete signs for the year. In fact, those years are close to 50/50 as to whether the markets are up or down. (There have been 22 of them since 1950.) It is only really powerful when the S&P is up after the first 5 days. As I reported on January 3rd, 2011 was a real oddity, as it became just the 6th year out of 39 years when the rule didn’t work. What is especially interesting is that there have been no back-to-back years when the rule hasn’t worked. So if for some reason, the S&P is still in positive territory on Monday evening, I shall be most excited.
This 5-day rule and the January rule are arguably somewhat hocus-pocus and could prove to be spurious correlations. A new AP report argues as much. Regarding the January rule, BTIG’s Dan Greenhaus recently pointed out that the January effect isn’t exclusive to January and can be applied to almost any month. Even O’Neill tells you his findings were “not enough to dismiss the superior importance of fundamental analysis.”
Perhaps these rules have little economic/fundamental basis. But if enough people with enough money believe it’s true, then it could turn into a self-fulfilling prophecy.