The S&P 500 Index gained 6.3 percent in January (6.45 percent counting dividends), its best performance to begin the year since 1997!
In fact, last month was the 19th strongest January performance since 1928. But January is typically a positive month for the stock market. What will February and the rest of the year have in store for investors?
Read on …
As I mentioned last week in Money and Markets, stocks have more than doubled since the March 2009 lows … but the level of investor bullishness has also nearly doubled … just since mid-November 2012!
|Could January’s impressive surge be a setup for a February fumble?|
Rapidly rising investor sentiment makes me a bit cautious near term, because too much greed and not enough fear is often a recipe for a swift market correction. But for now the trend in stocks remains to the upside.
Plus, January’s sizeable stock market gain bodes well for the rest of 2013, although perhaps not so much for the near-term direction of share prices. Let me explain …
January Barometer Signals Clearing
Skies and Higher Highs for Stocks
So what could such a strong January mean for stocks over the rest of this year?
Well, according to the esteemed Stock Trader’s Almanac, the “January Barometer” says that as the S&P 500 goes in January, so goes the year. And since 1950, this indicator has produced an 88.7 percent accuracy rate at predicting market direction, with just a handful of misses.
That’s a heck of a lot better than the track record of most Wall Street forecasts!
Digging deeper into the data going all the way back to 1928, Merrill Lynch finds that: The average annual return for the S&P 500 is 12.65 percent in years when January is up … compared to an average annual decline of 2.28 percent when January is down!
Of course the January Barometer is part of the bigger story of seasonality and its influence on financial markets. Historically, January is the third-best month of the year for stocks, right behind December and July! But that’s old news now that January is over and done with.
Unfortunately, February has not been as favorable for markets historically.
In fact, based on average monthly returns for the S&P 500 since 1928, February is the second-worst month of the year after September.
Also, 2013 is the first year of the four-year Presidential election cycle … and typically stock market returns in February are even worse during this phase of the cycle with the S&P posting an average decline of 2.25 percent.
Granted, these historical patterns don’t always repeat exactly. But from a seasonal perspective, this month would be a logical time to expect a market correction.
What is Sentiment Saying?
Aside from seasonal tendencies, investor sentiment is another key item to keep tabs on. In fact, besides having a good grasp of the overall market trend, sentiment is one of the most important items in every investor’s toolkit.
And on this score, sentiment appears to be getting a bit too bullish right now for my comfort level.
Last week, I pointed out that the American Association of Individual Investors (AAII) survey, a widely followed gauge of small investor sentiment, stands at the most bullish level since just before the market peaked last March.
You can also see sentiment extremes in other data including:
- The number of stocks trading above their 50-day moving averages …
- Extreme low levels in the CBOE Market Volatility Index (VIX), which recently fell to the lowest level since 2007, and …
- The ratio of trading volume in put option versus call option contracts.
All of these indicators are at or near extreme bullish levels right now. And in the past, such multiple, extreme sentiment readings have often preceded a shift in trend for markets.
While stocks remain in an uptrend for now, they may need to pause for a short-term breather before moving substantially higher. A correction of 5-to-10 percent would not be surprising given how over-bought many stocks have become, and February is a seasonal weak spot for the markets.
Steps to Consider Ahead
of a February Fumble
In my view, this counsels for taking some precautions with your portfolio right now. This does not mean you should abandon-ship and toss out all your long-term holdings on account of a temporary market pullback.
Instead, here are a few steps to consider …
#1: Help secure portfolio gains by using protective stops on some of your more volatile securities …
#2: Maintaining a strategic cash reserve may also be useful to provide extra buying power after a correction …
#3: Above all, keep your watch list up-to-date with securities you’d like to own for the long haul!
After all, a short-term market correction may provide you with very attractive entry prices for stocks or ETFs you’ve been waiting patiently to buy. As I pointed out previously, the investment roadmap I’m following this year calls for faster growth overseas — particularly in emerging markets — rather than the U.S.
So my personal watch list features high-quality stocks that earn a very high share of sales and profits internationally. Following this roadmap, my favorite sectors right now include: Energy, industrial, and technology (especially software).
After a potential February fumble in markets, two exchange traded funds you may want to take a closer look at are: SPDR S&P Oil & Gas Equipment and Services ETF (XES) and Power Shares Dynamic Software ETF (PSJ).