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Tom Madell

Tom Madell

Mutual Fund Research Newsletter is a free newsletter which began publication in 1999. It has become one of the most popular mutual fund newsletters on…

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Likely Dimmed Prospects for a Favorable Year

There is the feeling among many investment professionals as well as investors themselves that "as goes January, so goes the year." What this means is that in years when the stock market performs relatively poorly at the start of the year, there is a tendency for the market to underperform its norms over the entire year as well. Since the stock market has performed poorly this January, this would appear not to augur well for 2014. But is there any truth to this belief in the importance of January?

In a recent analysis reported in January on Forbes.com, a positive start for stocks in January has proven to be predictive of a positive return over the entire year. However, a negative overall January shows no relation to what happens for the rest of the year. But when both a negative result for all of January is combined with a negative first week of the year for stocks, as we had at the beginning of this year, then approximately 73% of the time the result for the entire year was indeed negative. In other words, there now appears to be a nearly 3 times greater chance of a negative year than a positive one! This adds further credibility to the higher probability of a poor year for stocks for this year.

Much more subjectively, it does seem strange that given the bull market we have been in that the S&P 500 index wouldn't have done better than -3.5% return in January. After all, January is the month that many investors are more active than usual, sometimes even putting any extra they might have received into the market, especially after seeing how lucrative last year turned out to be.

But a barometer I have frequently used with some success in the past that requires much more evidence to suggest possible serious trouble ahead is that stocks, from any point during a given year, go negative for at least a full 6 months. I have noticed that when this happens, more frequently than not, stocks may be in for an extended period of further rough sledding. Since the S&P 500 reached 1700 approximately 6 months ago, a further drop of about 5 to 6% would bring us back to that point, so anything more than that would push the return for 6+ months in negative territory.

Taking action ahead of only possible trouble ahead may seem to many people to be premature. After all, reducing your allocation to stocks, or even exchanging out of funds considered risky into less risky ones, while we still remain in one of the strongest bull markets ever, may be like predicting that the "sky is falling," as described in the fable "Chicken Little." But there is a difference: stock markets do suffer not so infrequent setbacks, while the kind of hysterical outcome described in the folktale has never happened.

But why not just "go with the flow," taking action only if a serious correction or even bear market is confirmed to have hit?

The problem is that once the above negative events are confirmed, an investor will have already suffered a serious falling off in the value of his/her portfolio. And under the pressure of a falling market, an investor may be tempted to make some quick, emotional decisions which may not turn out in his/her best interest. For example, he/she may oversell his/her portfolio, or wind up selling near the bottom of a correction, only to see stocks bounce back soon after. Or, he/she may continue to stick with a high allocation to risky stocks in the hopes of them soon getting to their prior levels, something that may not happen.

While taking a pre-emptive approach may be hard to do psychologically, and not an "ideal" solution, ones other options may subject one to the possibility of a shriveling of the gains one has already made.

One must recognize that there is really no "ideal" solution to the dilemma since stocks, after all, are inherently unpredictable. Selling with gains, even if not near the top, is considerably better than selling at a later point with lower prices, or even losses.

To quote Jonathan Burton, investing editor of Marketwatch.com and prior contributing editor at Bloomberg Personal Finance, Mutual Funds and Individual Investor magazines, and author of two books on investing:

Over time, trying to shoot out the stock-market lights is a recipe for shooting yourself in the foot -- or worse.

And,

Capital preservation is key for any investor. If you are fortunate to have enjoyed above-average investment returns in the past couple of years, take some profits off the table. The worst thing for an investor is being shaken out of the market at precisely the wrong time, as people who dumped stocks in 2008 and early 2009 have learned the hard way. With a diversified, risk-controlled portfolio, market corrections won't be as scary, and you'll have money to buy stocks when others are selling cheaply.

I couldn't agree more. My next article will give investors a game plan for how to accomplish this without requiring indiscriminant selling.

 

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