Chris Kuflik - ScotiaMcLeod Montreal

The old market adage states, "As January goes, so goes the year". This “‘January barometer” states that if markets record a gain or loss in the first month of the year, returns for the year will follow suit.  Is this indicator infallible and can the equity markets continue their assent?

Equity markets in North America posted gains for the month of January. There is research to support this historical bias, and using data going back to 1950 for the US markets (as published by Stock Trader's Almanac), this barometer has roughly a 74% accuracy rate, and a 90% success rate of simply avoiding significant mistakes (the market moving 5%, or more, in the wrong direction). While this information is US-based, it also applies to Canadian markets as our markets tend to follow the US market. Since 1950, there have only been 7 years where the S&P 500 moved more than 5% in the opposite direction than how the month of January closed. Interestingly, 4 of those 7 years where the barometer has been "broken," came within the past decade! In 2001, the market offered a quick rally of 3.5% in January before nose-diving to post the sixth worst year on record since 1950 -- down 13%. Contrasting that move was 2003, when the S&P 500 closed January in negative territory leading up to the beginning of the 2nd Gulf War, but as we know ended the year up 26.4%. In 2008, the Barometer was right on target, as January was a down month (-6.1% for SPX) and the rest of the year was abominable; posting a loss of -38.5% for 2008. In January 2009, we started the year much like 2008 ended, with a loss of -8.6%; but after a March bottom, the market got back on solid footing and ended the year with huge gains of +23.5%. Now, that is the kind of error you like to see! The most recent "error" in the Barometer was just last year in 2010 when we entered the year with a -3.70% loss in the S&P 500, yet the rest of the year was quite positive as the market scratched back from the summer doldrums and ended 2010 up 12.78%.

A point that bears repeating (that was displayed in the last two years) is that the “January Barometer” is notably better at predicting strong years than it is at predicting losers. Of the 24 losing Januarys since 1950, the market has followed up with down years 54% of the time (13 occurrences), with only 4 double-digit rallies following a bad month of January (2010 and 2009 being the most recent). These historical tendencies are just that, tendencies, and can obviously be wrong and shouldn’t serve as a primary indicator for anyone looking to tactically manage market risk.

Another theory as to the direction of the markets in the future is Dow Theory. A great deal of attention has been paid to Dow Theory, which is a method of analyzing market trends. It suggests that in order to receive a clear economic message from two indices (in this case the Industrials and Transportation) they need to be moving in a similar direction. The foundation of this tenant of Dow Theory is based around the concept that the Industrial and Transportation segments of the market are inherently linked. The idea is based around the principle that making goods (industrial) is just one part of the economy, while moving goods (transportation) is the other. In order for a trend in Dow Theory to be established, there needs to be a joint confirmation from both the indices. For instance, if Transports rallied, it is most likely a sign that Industrial will follow. In looking at the DJIA (Industrials), it has recently managed to move to new highs, while the Transports have faltered a bit recently. Could this be signaling difficulty in the months ahead? Time will tell.

While the overall North American markets have been on an uptrend, they are currently overbought, as they have been for the last several months. This does not mean that a market decline is imminent, but that investors should exercise caution at the current time. Despite the current state of the market we continue to find ideas which have good value, good dividends, strong fundamentals and good relative strength. We will continue to hope for higher markets but are prepared to become more defensive should the situation warrant it.

Please feel free to share this article with someone you feel could benefit from its contents.

Chris Kuflik

Associate Director, Wealth Management

Wealth Advisor

514-287-2931

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