Saturday, January 07, 2006

New Year Opening Rally Is a Bullish Sign

Anecdotal evidence suggests that the first week of trading in the new year provides a hint of what's to come over the balance of the year. In my own investing, I rely more on fundamentals than technicals, but with this past week's strong rally (S&P 500 up 3.0%, DJIA up 2.3%, and Nasdaq up 4.5%) ushering in the new year, I couldn't resist the temptation to spend a few hours over the weekend examining pure price behavior. Question: Is a rally during the first week of trading in January a bullish sign for market performance over the remainder of the year?

Using daily price data for the S&P500 going back to 1950, I have extracted returns during the first four trading days of each calendar year and paired these off with returns transpiring over the remainder of each year. The graph below shows a scatter-plot of the relationship between opening-week (defined as the first four trading days) and remainder-of-year (following the first four trading days) returns:

As is often the case with cause-and-effect relationships in the financial markets, there is a lot of shotgun-like "scatter" in the data, making it difficult to discern any clear-cut pattern. Upon closer inspection, however, I believe it is possible to glean a pattern embedded in the data. By ordering the four-day return data from low to high and dividing the 55 data points (one for each of the years between 1951 and 2005, inclusive) into five equal groups (quintiles), we can rearrange the data in the scatter-plot diagram to arrive at the quintile chart below:

With the data represented in this way, note the positive correlation between opening-week and remainder-of-the year returns:

  • Average remainder-of-year returns are highest when opening-week returns are highest. For quintile 5, with opening-week returns in the range from 2.25% to 6.0% (cf., this year's opening-week return of 3.0%), remainder-of-year returns have averaged 14%. On the other hand, when opening-week returns have been negative (quintiles 1 and 2), remainder-of-year returns have averaged a much lower 4% to 7%;
  • When opening-week returns have been above 2%, remainder-of-year returns have been positive (i.e., greater than zero) 83% of the time. On the other hand, negative opening-week returns have been followed by positive remainder-of-year returns a significantly lower percentage (55%) of the time.

With the first week of trading this calendar year (2006) having exhibited an historically strong performance (only eight of the 55 years between 1951 and 2005 have seen S&P 500 returns exceeding 3.0% over the first four trading days), the balance of the trading year should be up as well--assuming the past offers some guidance on what we might expect in the future.


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