While past performance is no guarantee of future stock market success, the Dow's quick start to 2013 could portend more gains ahead, says a forecasting tool created by the "Stock Trader's Almanac."
NEW YORK -- With the Dow Jones industrial average on track for its best January since 1989 and the Standard and Poor's 500 off to its fastest start since 1997, one of Wall Street's best-known and most-accurate prediction tools, dubbed the January Barometer, is flashing a green light for stocks.
This "early-warning signal" was devised in 1972 by Yale Hirsch of the Stock Trader's Almanac. Hirsch, a proponent of seasonal trading strategies, coined the expression, "As the S&P 500 goes in January, so goes the year." In short, an up January typically leads to an up year; a down January portends full-year weakness.
While there's no guarantee that what happens in the first month of a new year will continue for the remaining 11 months, history is on the side of investors, as is old-fashioned market momentum.
Since 1950, the January Barometer has registered only seven "major errors." The last time gains in January gave way to a significant decline for the year was during the 2001 bear market, when a 3.5% gain for the S&P 500 evaporated and it ended down 13%, Almanac data show.
The market's early gains this year have been driven by diminishing policy risk now that the fiscal cliff has been avoided and the debt ceiling debate has been put on hold until May. Ridding the market of uncertainty has been the catalyst for a transition in investor sentiment from pessimism to optimism, says Frank Holmes, CEO of U.S. Global Investors.
"What's missing," Holmes says, "is all the storm clouds and hand-wringing over fiscal policy."
Holmes is bullish on stocks in 2013, thanks to continued support from central banks around the world and China's commitment to keep growth strong.
As global growth picks up, he says investors will be more willing to pay more for each dollar of a company's earnings. That translates into higher price-to-earnings multiples, or P-Es. The S&P 500 closed Wednesday at 1502, or 13.3 times its estimated 2013 earnings. If the P-E multiple swells to, say, 15, market would trade at around 1700, or roughly 13% higher.
But Jonathan Golub, strategist at UBS, isn't so sure an up year for stocks in 2013 is a slam dunk. He says investors remain fairly defensive despite the market's recent ascent. Corporate earnings, he adds, remain challenged. What's more, he worries that the don't-worry, be-happy talk following the near-miss of the fiscal cliff will shift to a more sober dialogue later in the year on whether the U.S. economy, which is still weighed down by fiscal challenges, will be able to post meaningful growth in the future.
"That will be the new headwind," Golub says.
"Stocks are cheap" relative to history, he adds. "The question is what catalyst will unleash (a period of higher P-Es) and when that will occur."