January 2009 ~ As January Goes, The Year Goes
Every January we hear the phrase “As January goes, the year goes”. This mainstay market observation is almost as popular as “Sell in May and go away”. We can try to discount all the unique Wall Street sayings but the fact remains, the sayings come from observations and stats. This morning I read a stat that the returns produced in January are 90% accurate in predicting the direction of the markets for the year. Bummer news since this January captured the title of “Worst January Ever” with a decline of over 8% for the S&P 500. Is this decline a precursor to the rest of the year or will this year be different?
A couple things must be taken into context to be able to answer such a question. In our last few writings we have discussed “trading ranges” for the markets. Trading ranges get created because stocks are influenced by supply and demand which is controlled by investor’s beliefs of what a company’s stock is worth in the current environment and the environment they expect in the near future (6 to 12 months out). Recently the trading range for the S&P 500 has been 800 on the low end and 930 on the high end. This range has been created out of a perception that unemployment will reach 8.5% and the economy will begin to show signs of recovery in the second half of 2009. That was the perception at the end of December which is why the markets started the month at the top end of the range at approximately 930.
The month started with markets moving higher in the face of bad news giving the impression that the trading range could get pushed up into the high 900’s on the S&P and start to form what many would have started to claim as the bottom of this market with the trend starting to move upward. Unfortunately, as the month continued the perceptions began to change as negative economic news and countless announcements of layoffs persisted through the month. In the face of nothing but bad news it appears investors beliefs have begun to shift to the idea that we could see 10% unemployment and recovery for the economy will be delayed until 2010. As the perceptions changed the market moved towards the lower end of the range with the S&P ending the month near 820.
As I write, the markets look more like they have a desire to go test the lows created in November 08 (750 on the S&P500) than make any strives to go higher. Because of the importance of these lows in the big picture we would expect them to hold initially. However, the rule of thumb is that the longer the markets hang out at those lows, or test them more than once, more weakness is created and opens the door to the markets moving lower and creating a new trading range, some say as low as 600 on the S&P500, a 26% decline from where we are today.
With that kind of risk and no evidence for potential of reward, other than hope, we felt it best to sit on the sidelines by moving the small allocation we had in the S&P500 index to money market. There have been some improvements in the credit markets with short term rates moving higher indicating that there is less fear out there. In addition, the equity markets have ceased seeing massive sell offs which is encouraging that a bottom is near. With the improvements in the credit markets and interest rates we have continued to make small methodical purchases in some corporate bonds as well as rising rate funds. Looking out further, Gold has recently broken out of a range to the upside and has some tailwind behind it as many expect the end result of all this government stimulus across the globe to be inflation and a weak dollar. Outside of cash, select bonds, rising rates funds and gold there is very little in the markets that look enticing to investors. Market volatility remains elevated as most big money investors have abandoned the traditional “buy and hold” investment strategy and moved to technical analysis and trading. The lack of any stimulus to entice investors to take risk will put a lid on the upside potential of the equities markets for the foreseeable future.
Keeping all this in mind leaves investors with a simple strategy whether January dictates the year’s returns or not. Store up on cash, buy a little gold, buy a little of a rising rates fund and purchase select individual corporate bonds to create some yield and remain open, willing and curious for when signs of improvement begin to show.
Until next month I wish you and your family healthy and wealthy days.
**The opinions expressed are those of Colby McFadden as of 2/1/09 and are subject to change due to market and other conditions.