Wall Street bulls are pumping stocks based on the "first five days in January" indicator. This is a crazy way to assess valuations in 2020.
Stocks edged higher to new records this week despite the Iran scare. (Or maybe because Iran’s response proved the Gulf republic knows it has more to fear than us.)
Wall Street bulls are touting the gains made by stocks in the first five days of 2020. Near market close on Wednesday, CNBC Markets pumped:
Stocks finished the first five trading days of 2020 higher, setting up for potentially strong performance in the full year, based on an old Wall Street indicator.
They point to the Stock Market Almanac’s finding of a correlation in past years between first five day stock gains and year-end gains
When stocks finish that period higher, the S&P 500 has been positive 82% of the time at year-end with an average gain of 13.6%, according to Stock Trader’s Almanac and CNBC calculations.
But a serious analysis of this “indicator” shows it’s not much better than clutching your lucky rabbit’s foot and hoping for the best, or consulting a Magic 8-ball.
Before looking at the simple reason why this indicator doesn’t hold much water, it’s worth noting that the stock market’s 5-day gain was very tepid.
On Jan. 2, the new year’s first day of trading, the Dow Jones opened at 28,638.97. Five trading days later, it closed at 28,745.09 for a 0.37% gain. Over that period, the S&P 500 index rose a mere 8 points from 3,244.67 to 3,253.05 for a measly 0.25% gain.
The Nasdaq Composite took the most ground with a 0.99% increase from 9,039.46 to 9,129.24. So the stock market finished the first five days only barely higher.
And more importantly, based on the typical odds of an up year regardless of how stocks do the first five days, the indicator is not significant within the 95% confidence interval.
CNBC’s bullish graph above only goes back to 1999. Its bullish correlation of first five day gains translating to year-end gains 82% of the time goes back to 1950.
In 2012, a MarketWatch analyst pointed out if you look at the indicator for the Dow, and include all the data points going back to the late 1800s, the Dow had advanced at year-end 69% of the years it gained in the first five days. But it also rose in 65% of all years regardless of first five day performance.
Furthermore, since 1970 the Dow is more likely to gain in a year following a first five day loss. So this indicator can be framed in just the right way to sound good for markets, but it doesn’t actually tell us much of anything.
People taking these kinds of stories as investment or trading advice might as well consult their horoscope for stock tips. As the standard disclaimer goes:
Past performance is no guarantee of future results.
Even if we concede there is some merit to the first five day indicator, it’s at best a statistical composite of a theoretical “typical year. This year isn’t “the typical year.” It’s 2020, and stocks have never been more overvalued in history.