Bad January, Bad First Half: A Gloomy Omen For Stocks

When the SHKSCKPVIamp;P 500 is negative for both January and the first half, it usually finishes lower for the year.

Investment advisers are turning cautious and focusing on yield

As if Wall Street doesn't have enough to worry about during this mostly dreary year, history also is not on the side of a market rebound for the remainder of 2010.

A bad January often portends a poor full-year return, but when that bad start is compounded with a loss for the first six months, the odds get even worse for a positive 12-month return, according to research released Monday by Standard & Poor's.

Since 1900, when the market is negative for both January and the first half, full-year returns have been negative 77 percent of the time, with a median loss of 11.7 percent.

For a market grappling with high unemployment, sovereign debt worriesand growing belief that economic growth will be considerably less than earlier estimates, the quest for a strong 2010 just got a little tougher.

A concerned trader on the floor of the New York Stock Exchange.
Timothy A. Clary | AFP | Getty Images
A concerned trader on the floor of the New York Stock Exchange.

"Of course we all know that past performance is no guarantee of future results, but history does have a way of at least warning us to the possibility of further declines," Sam Stovall, S&P's chief equity strategist, wrote in an analysis. "And 2010 may be no exception."

January 2010 saw the S&P 500 fall 3.7 percent while the index dropped 7.6 percent for the six-month period. The last time both figures were negative came in the market meltdown of 2008, when the S&P lost 38.5 percent for the year. Conversely, the two measures were slightly negative in 2005 but the index gained 3.0 percent for the year.

The best showing the market had when January and the first half were both negative came during the economic recovery of 1982, when the respective losses were 1.8 and 10.6 percent, but the market roared back in the second half to post a full-year gain of 14.8 percent.

With no such economic resurgence likely on the horizon, the odds are stacking against a full-year stock market gain.

"We're having a major tug of war between the earnings and the economic data, and the economy seems to be far more sluggish than the earnings," Art Cashin, director of floor operations at UBS, told CNBC (see video below). "That tells us the economy may be staggering some."

Indeed, if one were to look only at earnings the numbers so far have been stellar: Positive net surprises are at 76 percent, while positive revenue surprises are at 71 percent.

But with investors looking more towards outlook, the strong second-quarter numbers haven't been enough to boost the market.

"We're having a major tug of war between the earnings and the economic data, and the economy seems to be far more sluggish than the earnings." -UBS Director of Floor Operations, Art Cashin

"The reason why the earnings season isn't generating sustained optimism is because these are backward-looking numbers and the incoming data are flashing a serious loss of momentum as the second quarter drew to a close," Gluskin Sheff economist and chief strategist David Rosenberg said. "What little we know thus far about the third quarter from much of the weekly indicators and regional manufacturing surveys strongly suggests that a further slowing in the pace of economic activity is in motion."

There are no easy solutions for investors in such an environment, particularly considering that the bond market appears to be pricing in a very slow recovery and sector losses are broad-based.

In an otherwise-rosy second-half outlook, Boston-based LPL Financial said the market would weigh a series of headwinds and tailwinds that would result in both volatility and churning in the major averages.

As such, LPL encouraged clients to focus on yield and invest in a mixture of high-yield and emerging market bonds, real estate investment trusts and dividend-paying stocks.

"To thrive in the transitioning markets we expect in the second half of 2010, several considerations may contribute to help investment success, including focusing on yield, finding opportunities in the face of headwinds, seeking benefits from the elevated volatility, and utilizing a more active rebalancing approach," the firm said.

LPL also is recommending investing in bank loans, commodity asset classes, municipal bonds and small-cap equities.

Similar defensive strategies are being employed elsewhere.

Bank of America Merrill Lynch advised clients to shift out of cyclicals and into defensive sectors such as healthcare, consumer staples, telecoms and utilities.

Strategists are moving away from broad market plays and looking for dependability and quality as Wall Street grapples with a moribund economy.

Nadav Baum, executive vice president at BPU Investment Management in Pittsburgh, is telling investors to bank on a return to the mean with stocks after a rough decade and to look further out on the timeline.

"We've got to get away from the whole analyst estimates and beating estimates and ask, 'How's your business? Is your business doing well?'" Baum said. "2008 is too fresh, and when you get a string of bad news all they think is ... 'I'm going through this again.' There's a lot of emotional knee-jerks going on with headline news."