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Two Patterns At Play With The January Effect And The Presidential Cycle

01/27/11 08:48:20 AM
by Billy Williams

Two patterns at play could take the market higher despite current shifts under way if you know what they are.

Security:   SPX
Position:   Buy

While commodity markets and precious metals are firming up for a secular bull market, there are key patterns under way that must be taken into consideration when formulating a strategy for the coming year. One is the January effect pattern, which shows a strong correlation between the performance of the first five trading days of January and the overall performance of the market in the year to come.

The first five trading days of 2011 were up and, according to past performance of this phenomenon, bodes well for the coming year. In the past, this has occurred 38 times, with 33 of those occurrences resulting in an up market, achieving an 87% accuracy rate for the future performance of the stock market.

The Stock Trader's Almanac's "January Barometer" states that if the market is up in January, 90% of stocks will end the year up as well.

FIGURE 1: S&P 500. The S&P has been on a bullish run for the last two years, with Wall Street, the January effect, and the Presidential cycle all pointing toward strong performance in 2011.
Graphic provided by:
In addition, market analysts at 12 of Wall Street's largest firms forecast the market to climb 9% higher this year, according to a Bloomberg survey. Goldman Sachs has, in the past, predicted 12.10% growth accurately for the Standard & Poor's 500 and predicts 15.30% growth for this year.

The second pattern that is adding fuel to a potential up year for the markets is the Presidential cycle.

This will be the third year for the Obama administration, which has experienced a rise of 41% in the Dow Jones Industrial Average (DJIA), where the five past Presidents have experienced a rise by at least 35% in their first two years in office. According to the outline of this pattern, the overall DJIA average for a President who saw these 35% plus gains in their first two years in office went on to see an average of 21.80% gains in their third year.

This cycle isn't reserved exclusively for a small group of Presidents either, as the third year of any President's term has resulted in being very positive for the market since 1945. The S&P has returned an average of 17.13% without a single down year, making this a reliable pattern to keep in mind as 2011 goes forward. See Figure 1.

In addition, historical indicators are pointing toward a very robust 2011 for the stock market and it is reasonable to project returns between 9% to 17%.

The S&P is already up 2.9% just after it rose 10.2% in the previous fourth quarter that ended 2010.

However, unemployment is hovering between 9% to 10% and real unemployment projected at 18% across the country. Bullish sentiment is being reported as high as 52.3% by the American Association of Individual Investors, which is significantly higher than the long-term average of 39% and approaching a five-year high.

Given that unemployment is still very high and the investing public is overly bullish, it would be to your benefit to stick to sectors that have high relative strength and hold up well during pullbacks and corrections.

Stick to material, commodity, and energy stocks, as they are likely to benefit the most, according to the current state of the market as well as the January effect and Presidential cycle patterns that are helping drive it forward.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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Date: 02/01/11Rank: 5Comment: 

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