Bear with us as we set aside fundamentals for a moment.Much has been made about a slew of popular bullish stock market indicators that have been confirmed since the beginning of the year. Lets review a few:
- January effect: A positive January for stocks has led to a positive year 86 per cent of the time since 1945.
- Election year: The fourth year of a presidential term is usually a good one for stocks. In fact a positive January during an election year has led to a positive year 100 per cent of the time.
- The early warning signal: Also known as the ‘S&P 5-day rule,’ if stocks are positive during the first five days of January, then January and the full year are positive 86 per cent of the time.
- The Super Bowl Indicator: When a team from the old NFL (NFC division) wins the Super Bowl, the S&P 500 rises for the year 78 per cent of the time.
No one knows more about this stuff than S&P’s Sam Stovall, who wrote the book on Wall Street rules of thumb. Literally. It’s titled The Seven Rules of Wall Street. And his father, Wall Street legend Bob Stovall, is the Super Bowl indicator’s official custodian.
Sam’s latest Stovall’s Sector Watch addresses these indicators. And he starts off with the warning you’ll get from any piece of investor advice: “Past performance is no guarantee of future results.”
Having said that, Stovall notes that predictive power of these beginning-of-the-year indicators aren’t completely without merit. He argues there are strong “behavioural reasons” that could drive investors to pour into stocks. From his note:
Investors are a lot like dieters; they look to January as a new beginning. With cash on the sidelines, combined with the desire to take advantage of the more favourable tax treatment offered by long-term capital gains, investors are likely to reinvest these assets in opportunities that are perceived to reap rewards over the coming 12 months.
But he suggests a targeted approach to investing over buying the whole S&P 500. It’s called the January Barometer Portfolio, which “uses January performances for sectors and sub-industries as a clue to their results for the coming 12 months.” From his note:
As I wrote in my book The Seven Rules of Wall Street, which leverages time-tested rules of thumb to create market-beating portfolios, investors could have reaped rewards by taking a cue from the three S&P 500 sectors or 10 S&P 500 sub-industries that posted the strongest results during January. Since 1990, a portfolio consisting of an equal weighting to the three best performing sectors in January posted a compound annual growth rate of 8.0% in the following 12 months (February through January), versus 6.6% for the S&P 500, and beat the market in nearly two of every three years. The sub-industry-level results were even more encouraging. Since 1970, a portfolio consisting of an equal weighting to the 10 S&P 500 sub-industries with the best January performances went on to post a 12- month CAGR of 14.4% versus 6.8% for the S&P 500 (excluding dividends). What’s more, this January Barometer Portfolio of sub-industries beat the market nearly 70% of the time. Of course, there’s no guarantee that what worked in the past will work again in the future.
Of course, this isn’t an air-tight investment strategy. Stovall is the first to admit it. Again, from his note:
No technique works every time, and the same holds true for the January Barometer. Last year’s two January Barometer Portfolios (sector and sub-industry) underperformed the broader market. While the S&P 500 rose 2.0% from January 31, 2011 through January 31, 2012 (excluding dividends), the three sectors gained 0.5%, while the 10 sub-industries advanced 0.6%.
The recent underperformance of the Barometer Portfolio is probably a turn off. But Stovall invokes another popular rule of thumb: Murphy’s Law. From his note:
But I believe Murphy’s Law applies to investing as well: The year you give up on a time-tested investment strategy that has suffered through a batting slump is the year in which it begins to outperform once again.
So, are you willing to bet that the Barometer Portfolio will be a home run this year? If so, here are the sectors and sub-industries you should be in:
- Sectors: Financials, Information Technology, Materials
- Sub-industries: aluminium, Construction & Farm Machinery & Heavy Trucks, Diversified Metals & Mining, Fertilizers & Agricultural Chemicals, Internet Retail, Investment Banking & Brokerage, Life Sciences Tools & Services, Multi-Sector Holdings, Other Diversified Financial Services, and Real Estate Services