There are a number of calendar and seasonality cliches and theories about the markets, some of which hold true under testing and some of which don't. The January Effect is one of these, which states that the performance during the first month of the year gives a good indication as to the total year's performance.
With tomorrow the end of the sixth trading week of 2012 and such an impressive performance in stocks so far (7.39% gain in the S&P 500 Index based on Thursday's close), I decided to analyze the historical market performance over the first 6 calendar weeks of the year to give a unique perspective.
I was looking for correlation between a strong "First 6 weeks" and what the market does on a yearly basis. The results were strong and surprising, in my view.
Using S&P 500 (SPX) (SPY) weekly data over the past 40 years, going back to 1972, allowed for a fairly large sample size and also a vast variety of bull, bear, and flat markets.
Here is the bulk data below, which shows the gain/loss for the first 6 weeks of the year and for the entire calendar year. Positive gains are shown with "W", Losses with "L":
SPX Data Since 1972
The bolded "W/L"s indicate the instances where the first 6 weeks did not correlate to the full year performance. There were only 10 times out of 40 where this occurred — in other words, 75% of the time the performance in the first 6 weeks foretold what the overall market gain/loss would be for the year.
In addition, there were only 2 instances where the market was UP in the first 6 weeks, but ended the year down — (1994 and 2011) — and both of those years had a net yearly loss of less than 1.5% (basically flat). So this "Up beginning, Down Year" result is only 2% of the overall sample size and 8.6% of the "Up beginning" samples.
Another way of stating that is that 91.4% of the time over the past 40 years, an Up first 6 weeks resulted in an Up year. Thus the past data indicates that the strong open to 2012 is very likely to result in a market gain for the year or a "flat" market in the worst case scenario.
Now let's take a look at the 'leverage' that a strong year open means for the full year performance … the average of the 21 "Up 6, Up Year" years was 5.93% gain for the first 6 weeks and 19.20% gain for the year. This gives us a "leverage factor" of 3.24. Projecting this to the 7.39% gain the SPX has achieved thus far in 2012 (Friday's trade action notwithstanding), this gives a projected gain for the year of 23.94%.
That would push the SPX to a potential year end target of 1560.19. This is certainly a higher number than many analysts are forecasting. But actually, if you take a look at the SPX Weekly Chart below, this would take us right back to the highs of 2007 just before the global economic crisis hit.
SPX Weekly Chart
So you can see that this potential upside target for 2012 would in fact basically retrace all of the losses incurred since 2007. This is also a logical resistance/pause/reversal area for the markets.
Since we've had such a strong gain in the first 6 weeks, let's also take a look back at the most similar years since 1972 to see how 2012 may shape up (if history is any guide). There were 7 years where the market gained between 5% and 10% in the first six weeks:
Note that the similar years (barring 2011) all had market gains of 19% to 31% on the year, which also falls in line with the leverage forecast calculated above.
The 2011 example (5.7% gain in the first 6 weeks, market ended year virtually flat unchanged) is part of the caveat to the overall very bullish tone of this data. Please note that this "First 6 Weeks" indicator has NOT worked as a harbinger of the overall market performance in the past 3 years. One could theorize that the "January" or "6 Week" effect may have been too widely known and traded and the market thus bit the "easy money" in the tail.
While in my view think the overall weight of the 40 years of data is strong and we should see a 'reversion to the mean', the fact that this hasn't worked correctly as a market prognostication tool since 2008 is something to keep in mind when you begin drooling over a potential run to SPX 1500+ this year.