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Okay, 2008 wasn’t so good. Fortunately, that is now in the past. The question today, then, is “what happens in 2009?” As it turns out, investors often get some very useful early clues within the month of January. Let’s take a look this week at one of those early clues.

About Those First Five Days of January

First, it is “shameless plug” time. Exciting news! This month my new book Seasonal Stock Market Trends: The Definitive Guide to Calendar-Based Stock Market Trading will be released by Wiley. Well, okay, it''s exciting to me anyway. In any event, the very first “trend” that I write about in the book is one that was discovered by Yale Hirsch many years ago and revealed in the fabled Stock Traders Almanac, put out annually by the Hirsch Organization. It involves simply analyzing the performance of the Dow Jones Indsutrial Average during the first five trading days of a new calendar year. The theory is quite simple: if the stock market registers a net gain during the first five trading days of the year, the rest of the year will be up. And conversely, if the first five trading days of January witness a decline in the stock market, then the market should in theory decline further by year end. Sounds a little “too simple” right? 

In reality it would likely not make much sense for an individual to base his or her entire investment strategy on the performance of five trading days. Nevertheless, the results are quite interesting and offer a good “weight of the evidence” tool to anyone willing to pay attention.

The Results

Table 1 displays:

• The percentage gain or loss for the Dow Jones Industrial Average during the frst five trading days of each calendar year since and including 1944.
• The percentage gain or loss for the rest of the year (i.e., starting at the close of trading on the fifth day of January).
• Did the first five trading day period register a gain, yes or no?
• If the first five days were up, was the rest of the year up or down?

Table 1 – Year-by-Year Results

By The Numbers

Let’s look at a few performance figures:

• A “bullish signal” occurs when the first five trading days of January show a net gain.
• A “bullish period” extends from the close on the fifth trading day of January following a bullish signal through December 31st of that year.
• A “bearish signal” occurs when the first five trading days of January show a net loss.
• A “bearish period” extends from the close on the fifth trading day of January following a bearish signal through December 31st of that year.

Using these terms here are some of the important results to note:

• $1,000 invested only during “bullish periods” grew to $41,913 by 12/31/2008.
• $1,000 invested only during “bearish periods” grew to just $1,564 by 12/31/2008.
• The average daily gain during bullish periods was 2.5 greater than the average daily gain during bearish periods.
• The annualized rate-of-return during bullish periods since 1944 was +9.4%.
• The annualized rate-of-return during bearish periods since 1944 was +3.7%.

If the first five trading days of the year are UP:

• # of times the first five days are UP: 39
• # of times the rest of the year is UP if the first five days are UP: 32 (82%)
• # of times the rest of the year is DOWN if the first five days are UP: 7 (18%)

Average gain for rest of year if the first five days are UP: +11.1%

• Average gain for rest of year if rest of year is UP after first five days are UP: +16.0%
• Average decline for rest of year if rest of year is DOWN after first five days are UP: (-11.0%)
• Best gain for rest of year if first five days are UP: +43.7% (1954)
• Worst loss for rest of year if first five days are UP: (-24.2%) (2002)

The most significant number of those above is the fact that the market has moved higher 82% of the time after the first five trading days of the year are up. This suggests strongly that if the first five days of the year witness an advance in the market, we should give the bullish case every benefit of the doubt as the year progresses.

If the first five days are DOWN:

• # of times the first five days are DOWN: 25
• # of times the rest of the year is UP if the first five days are DOWN: 11 (44%)
• # of times the rest of the year is DOWN if the first five days are DOWN: 14 (56%)
• Average gain for rest of year if the first five days are DOWN: +3.7%
• Average gain for rest of year if rest of year is UP after first five days are DOWN: +22.0%
• Average decline for rest of year if rest of year is DOWN after first five days are DOWN: (-11.4%)
• Best gain for rest of year if first five days are DOWN: +39.7% (1986)
• Worst loss for rest of year if first five days are DOWN: (-31.1%) (2008)

As you can see, there is a much lesser tendency for the market to advance during years when the first five trading days are down (only 44% of the time), than when the first five trading days are up (82% of the time). Still, in the long run the stock market goes up, and despite the fact that there have been more declines than advances by the stock market following a down five days at the start of the year, the average return during all 25 of these years was +3.7%.

Up First Five Days versus Down First Five Days: The Rest of the Year

Too fully appreciate the difference in stock market performance between those times that the first five trading days of the year witnessed a gain versus those times that it witnessed a loss, consider Chart 1.

• The top line in Chart 1 displays the growth of $1,000 invested only between the close of the fifth trading days of the year and the end of the year only during those years when the first five trading day period was up.
• The lower line in Chart 1 displays the growth of $1,000 invested only between the close of the fifth trading days of the year and the end of the year only during those years when the first five trading day period was down.
  
   

Chart 1 – Growth of $1,000 if 1^st 5 Days UP (Blue Line) versus growth of $1,000 if 1^st 5 Days DOWN (Purple Line) since 1944

From the graph in Chart 1 it is pretty obvious that if you had to choose between investing only during years when the first five days show a gain versus those years when the first five days show a loss, the up years win by a landslide. That $1,000 invested only during the “5 Up” years would have grown to $41,913 by the end of 2005. Conversely, $1,000 invested only during the “5 Down” years would have grown to just $1,564 by the end of 2008.

A piece of bad news associated with this approach is one thing it would not have done for you. You would not have missed some very nasty bear raids (1966, -20.3%; 1973, -18.6%; 2002, -24.2%). Likewise, you also would not have participated in some major bull market rallies (1955, 1982, 1985, 1986, 1988, 1991 and 1998 all witnessed market advances in excess of 20%, in spite of the fact that the vaunted “first five days” showed a loss). Still, given that nothing is perfect, the results displayed in Chart 1 remain quite compelling.

Summary

One can argue the merits of “the first five days” method of analysis. If anyone has an obvious and solidly logical explanation as to why a bullish first five days should be followed by a further gain for the rest of the year, please let me know. Still, the numbers are what they are. As a proud graduate of “The School of Whatever Works,” anytime I find something with 60+ years of history and an 82% success rate, I make a note and pay attention.

If the first five trading days of January 2009 registers a gain (as this is being written the odds look pretty good) there is no guarantee that the stock market will be higher still by the end of 2009. In fact, just last week I presented some information suggesting that the stock market would rally early in the year and then experience another plunge. So what does it all mean?

As always, time will tell.

To search for previous articles written by Jay Kaeppel, please click here.

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

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