Opinion: A bear market in stocks became more likely today
The first trading day of the year is a bellwether of the full calendar year
CHAPEL HILL, N.C. (MarketWatch) — The stock market's plunge on this first trading day of the year markedly increases the odds of a bear market in 2016.
That's because the stock market's direction in any given year's first trading day is more often than not a good indicator of how it does for the rest of that year. That relationship is significant at the 95% confidence level that statisticians often use to conclude that a pattern is genuine.
Consider the historical odds of a full-year gain when the first day is positive: 74%, compared with 51% when the stock market fell on the first trading day of the year. (See chart above.)
Consider, also, the difference in the Dow's post-first-day return depending on how it does on the first trading day: 9.5% versus 4.2%.
To be sure, as you can see from the chart, the pattern does not amount to a guarantee. Calendar year 2014 was an exception, you may recall: The Dow Industrials declined 0.8% on the first trading day and, yet, from then until the end of the year, proceeded to gain 8.4%.
But traders are having a hard time overlooking what happened in 2008, just as the Great Recession was gathering steam. The Dow that year shed 1.7% on the first trading day, which is even less than its opening plunge this year. Ominously, the Dow that year lost another 32.7% through the end of December.
Why does the pattern work? My hunch is that it's because investors are slow to react to new information, which is one reason why the stock market exhibits trends. To test this hunch, I examined the ability of the first trading days of all months to "predict" the market's return for the next 364 days. Sure enough, the pattern exhibited by the first trading day of January holds up for those other months as well.
In fact, the pattern is even stronger in the case of some of those other months. Take March, for example: The Dow's next-year gain following an up day on the first trading day of March is 10.7%, versus only 2.3% following a decline on the first trading day of the month.
Traders don't endow those first trading days of other months with as much significance as they do in the case of January, of course. That's no doubt for psychological reasons, since it's human nature after New Year's to focus on the coming year. But, statistically, the pattern is fairly universal.
That's one reason that traders often say that the most bullish thing the stock market can do is go up. That most definitely is not what it's doing to kick off 2016.
Posted by: sarah_oz@yahoo.com
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