Everyone wants to start on the right foot.
Investors are no different.
As trading gets underway for 2010, the stock market faces a big test: Whether its performance will be lifted by the phenomenon known as the January Effect or stifled by continued uncertainty about the economy.
The January Effect is the buying blip that often occurs with the start of a new tax year. Investors who sold stock before the end of the old year to claim a tax loss reinvest that money when trading begins again.
Market historians and investors watch January performance carefully because it frequently sets the tone for the rest of the year. With few exceptions over the past 50 years, the market performance during the first month of the year establishes a trading pattern that appears to influence market outcome for the next 12 months.
Santa’s Significance
Historically, a positive January Effect is more likely to happen if there has been a Santa Claus rally at the end of the prior year. This idea has been a part of Wall Street lore since the 1800s. It was memorialized in the ditty: “If Santa fails to make a call, the bear will come to Broad and Wall.”
Although there is no is actual consensus on the exact dates of the rally, it’s defined as beginning from a few to several days before Christmas. If it happens, the Santa Claus rally ends either in the current year or two or three days into the next year.
While the markets were somewhat flat going into the last few trading days of 2009, they appear to rally up through the point at which Old St. Nick grabbed the reins of his sleigh on Christmas Eve.
With today being the first full trading day of 2010, the markets have started with bang. The S&P was up nearly one and a half percent from the opening bell, and the Dow jumped more than 160 points.
Stocks and commodities may have started on a positive note, but the dollar has continued its slump, dropping to nearly $1.44 against the euro. On the weaker dollar, oil climbed back above $80 per barrel, and gold pushed up $20 to a high of $1,123.65 on the spot market.
Despite these positive stock and commodity numbers on this, the first official trading day of the New Year, lingering doubts about the economy could still trip up the markets.
According to the Labor Dept. figures, unemployment showed a marked improvement as 2009 came to a close with employers cutting just 11,000 jobs from the economy. Prior to that point, the economy had been losing as many as 600,000 jobs every month.
Depends on Which Source You Believe
In a survey conducted by Thomas-Reuters, most economists, however, believe that the Labor Dept. numbers are way off. A majority are now forecasting jobs cuts of 23,000, more than twice the amount reported by the government. If employment figures are adjusted upward, this could undermine the market momentum, triggering an early selloff.
Going forward, the bigger issue to investors may be the duration and breadth of the government stimulus programs. Specifically, market watchers are increasingly concerned that a healthier economy will lead the Federal Reserve to pull back its stimulus measures, leaving investors uncertain as to whether the economy has the ability to flourish on its own.
Investors are particularly apprehensive about the Fed pushing interest rates higher.
Right now, interest rates for banks are effectively at zero. This has allowed banks to borrow as much as they want at real no cost or premium.
The banks may have virtually unlimited access to cheap money. But as most frustrated individual and business borrowers have found, they still are not lending. Instead, the banks have been boosting their balance sheets through short term speculating on the stock and commodity markets.
With all of the money sloshing around in their coffers, policymakers from the White House to the Congress are pressuring the banks to re-open the borrowing spigot. This may help borrowers on Main Street, but over the short term it could drain a significant chunk of liquidity from the markets, causing a trough in prices.
A continued strong performance by the market could also be threatened if fourth-quarter earnings do not meet investor expectations.
Investors already have been pricing in strong earnings reports, especially since the outcomes are being compared against companies' terrible results from the final three months of 2008. But if the earnings reports aren't strong enough and companies still are showing weak revenue growth, January could end up being a disquieting month in the market.
Clearly, it’s still too early to know which way the January winds will carry the market for the coming year. But in light of where we’ve been, it’s a relief to start this year on a positive note.
John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com
