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Okay, so I’m not exactly Muhammad Ali when it comes to prose (or even Johnny Cochrane for that matter).  Nevertheless, if history is an accurate guide – and it is more often than most people realize – we should be giving the bullish case every benefit of the doubt during the current calendar year.  As many market followers are undoubtedly aware by now, there has never been a year ending in the number 5, (1885, 1895, 1905, etc.) that has experienced a down year.  While one can effectively argue that this phenomenon is a quirk and a meaningless static (“How could what happened 10 years or 100 years ago possibly matter today?”), the fact remains that many seasonal patterns exist in the stock market and repeat with surprising frequency.  So what can we expect going forward?  Well, first let’s take a look back at what’s happened in the past.

Table 1 shows the annual performance for the Dow Jones Industrial Average during “5 years” in the last century.  The average annual performance is an eye-popping +35.0%.  The “worst” year was 1965 when the Dow was up only 10.9%. 

Table 1 – Dow performance during years ending in 5

To fully appreciate the consistency of market strength in past “5 years,” it is also instructive to look at the monthly returns.  Table 2 displays the monthly gains and losses for the Dow during “5 years.”

Table 2 – Monthly Dow performance during years ending in “5”

Points of Interest:

• Every calendar month showed a gain on average
• March was the only month that was down more often than it was up.  
• The most consistent months historically have been January and December, followed by April, October, November, June and July.
• In 121 months (including January of 2005) during “5 years,” 89 months have shown a gain, while only 32 months have shown a loss. 

Charts 1 through 10 display the percentage gain as it accumulated through each “5 year."

Chart 1 – % Dow Gain for 1905

Chart 2 – % Dow Gain for 1915

Chart 3 – % Dow Gain for 1925

Chart 4 – % Dow Gain for 1935


Chart 5 – % Dow Gain for 1945

Chart 6 – % Dow Gain for 1955

Chart 7 – % Dow Gain for 1965

Chart 8 – % Dow Gain for 1975

Chart 9 – % Dow Gain for 1985

Chart 10 – % Dow Gain for 1995

Another interesting way to look at the performance during “5 years" is to examine each year to find the worst decline within that year.  In other words, if you got in at exactly the worst time during any “5 year," how much of a decline would you have to sit through before things turned around.  This information appears in Table 3.

Table 3 – Worst Intra-Year Drawdowns

As you can see in Table 3, the worst intra year decline by the Dow during a “5 year” was –15.9% in 1915 (which interestingly, was ultimately the best performing of all “5 years”).  The median worst decline was –9.9%.

So what does this all mean?  Are we guaranteed an up year in 2005?  Should we just put all of our money in the stock market and check back on December 31^st?  While I am a big believer in seasonal patterns I don’t believe that that is quite the message.  I think the real message is that we should be giving the bullish case every benefit of the doubt during this particular year.  In other words, do not allow yourself to be shaken out of the market based on something news related, nor on some prediction of declining earnings, rising interest rates, a potential slowing economy, twin deficits, etc.  There is always enough bad news out there to allow a person to justify sticking his or her head in the sand.  But now is not the time to get weak in the knees based on news or divergences or fundamentals, or anything of the sort.  The only thing that should shake you out of the market is the market itself.  If the major averages start to break down below their long-term moving averages, then certainly it makes sense to play some defense.  Otherwise, the best advice is to stay the course.

In 1975, the stock market shot higher in January and the technical analysts of the day said there was no way it could follow through because there was an unclosed gap between December 31^st, 1974 and January 2^nd, 1975.  And of course, “all gaps are eventually filled,” so the market was bound to go back and close that gap.  The wait for the “inevitable gap closing” presently stands at 30 years and counting.  

In 1985, the market “had to go down” because it was a “post-election” year.  And as all good market follower’s back then knew, post-election years were “always” down years for the stock market.  Of course, the problem there was that people tend to look at recent history and assume that that is the future (this still happens today).  Back in 1985 investors were conditioned to believe that the market would experience a sharp decline sometime during a post-election year, because that is exactly what had happened previously in 1961, 1965, 1969, 1973, 1977 and 1981.  Of course, since then, the post-election years of 1985, 1989, 1993 and 1997 all were up years for the market.  Also, in October 1985, the Dow Industrials broke out to a new high.  At the time it was the only average to do so.  I well remember a piece from a leading market newsletter writer of the day that highlighted the fact that the Dow Industrials had made a new high, but that every other major market measure – and he listed them all; the advance/decline line, the S&P 500, the NYSE, the AMEX, the NASDAQ, large-cap, small-cap, etc., etc. – had not.  This he argued, was proof positive of a “major divergence” and that this type of “non-confirmation” clearly pointed to lower stock prices.  Under the category of  “Oops," just a month and a half later the Dow was 13% higher and five months later the Dow was 32% higher (and all of the measures he listed had long since “undiverged," and run to new all-time highs also).

The bottom line (in my opinion) is this:  if you are inclined to protect yourself by selling as the market declines, there is no reason not to continue to do so.  This is because – despite my bullish slant here – the real paradox here is that what happened 10, 20 or 100 years ago really doesn’t matter.  If the Dow ultimately decides to ignore history and go down 30% this year, it would be foolish to hold on and ride it all the way down simply because up until now “5 years” were a “sure thing.”  So if the major market averages start to break below their long-term moving averages, it makes sense to protect yourself.  However, should this happen, the most important thing to remember is the need to get back into the market if things turn around to the upside once again.  In a nutshell, contrary to popular belief, it is okay to stick your head in the sand.  The trick is that  it’s not okay to leave it there.  


Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site

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