Jan. 31, 2014, 1:10 p.m. EST
Don’t dump stocks just because January was a loss
Opinion: Here are ways to rebalance risk if you believe the January indicator
By Mark Hulbert, MarketWatch
Getty Images
The year-to-date decline in stocks points to a rough year for equities, according to the so-called January indicator, which is based on the historical tendency for the market’s direction in January to set the tone for the next 11 months.
Given that January has been a solidly down month for the market, followers of the indicator may be considering whether to unload some of their stocks or replace some of their riskiest bets with more-conservative holdings — such as stocks of the largest companies that are trading for relatively low price-to-/book ratios, a common measure of net worth.
The January indicator, also called the January barometer, traces back to at least 1972, when newsletter publisher Yale Hirsch first mentioned it in his annual Stock Trader’s Almanac. The indicator has continued to work just as well as it did before, which is in itself noteworthy. It is more common for stock-market patterns to stop working once they are discovered and lots of investors begin to pay attention to them.
Global stocks fall sharply
Paul Vigna and Charles Forelle discuss the state of global markets, and Sital Patel looks at banks and Super Bowl sponsorship.
Consider: In the years since 1973 in which the S&P 500 SPX -0.65% rose during January, the index proceeded over the next 11 months to gain an average of 11.2%. That compares to an average February-through-December gain of just 0.2% in those years in which — like this year — the market fell during January.
“Compared to other market-timing indicators that are out there, this one appears to be one of the most accurate,” says Michael Cooper, a finance professor at the University of Utah who has extensively studied the January indicator.
Given that, shouldn’t you immediately dump all your stocks? Cooper says no, for two reasons. The first: Though the odds of an up market this year now are lower than they would have been had stocks risen in January, those odds still slightly favor the market rising from now until the end of this year.
According to Sam Stovall, chief equity strategist at S&P Capital IQ, the S&P 500 since 1945 has risen 56% of the time following down Januarys. That is lower than the 84% frequency of February-through-December gains following a higher market in January, but still positive.
The second reason it would be unwise to dump all your equities right now, according to Cooper, is the lack of any plausible explanation for why the January indicator should work. He says he and other researchers have tested a number of theories and found each of them wanting.
The absence of a convincing explanation “raises serious questions about whether it will continue working in the future,” Cooper says, since without many more years of data, it always is possible that “by sheer coincidence” a meaningless indicator will continue working — for a while — even after its discovery.
Upon balancing these considerations with the January indicator’s track record, Cooper says that, given this January’s performance, we might want to reduce our portfolio risk but not give up on stocks entirely. For example, if you own stocks on margin — borrowing from your broker to buy more than you otherwise could — then he suggests selling enough of your stocks to eliminate that debt. And if you are particularly risk-averse, you should build up some cash in your equity portfolios.
Alternatives to stocks
There are several alternatives to common stocks that are currently recommended by several of the advisers tracked by the Hulbert Financial Digest who have beaten a broad stock-market index over the past 15 years. One is bond mutual funds, though these advisers are favoring funds with shorter maturities, in order to reduce their vulnerability to the higher rates that are the likely consequence of the Fed continuing to taper its monetary stimulus program.
Their two most recommended bond funds are the Fidelity Floating Rate High Income FundFFHCX 0.00% , with a 0.7% expense ratio, or $70 per $10,000 invested; and the Vanguard Short-Term Investment-Grade Fund VFSIX +0.09% , with a 0.2% expense ratio. The first of these funds invests in floating-rate bank loans, while the second invests in investment-grade short-term debt.
Another category of alternatives is preferred stocks, which typically behave more like bonds than common stocks. The preferred stock the top performers currently like most is the 6.75% Preferred C of AES Corp. AES.PC -0.36% , which generates and distributes electricity.
Two other categories popular among these market-beating advisers contain more-volatile investments. One is master limited partnerships, which trade like stocks but return much of their gain to investors as income, though the advisers acknowledge that some MLPs are highly leveraged and quite risky.
Their most highly recommended MLP currently is Kinder Morgan Energy Partners KMP -0.25% The other category is gold and other precious metals. The advisers particularly like Freeport-McMoRan Cooper & Gold FCX 0.00% , a mining company.
Cooper points out that it also might be a good idea to also reduce risk among the stocks you continue to own. For example, you could favor large-cap value stocks — those trading at relatively low price/book ratios. His research found that a down January translates into particular rough going for stocks at the opposite end of the spectrum — small-cap growth ones.
Several large-cap-value stocks currently are quite popular among the advisers who have beaten the market over the long term. Each stock sports a market cap in excess of $100 billion and a price/book ratio below that of the S&P 500, which currently stands at 2.5.
They include telecom company AT&T T -0.09% , oil firm Chevron CVX -4.14% , computer-equipment maker Cisco Systems CSCO -0.30% industrial conglomerate General ElectricGE -1.45% , chip maker Intel INTC -0.81% , and banking giant Wells Fargo WFC -1.54% .
Mark Hulbert is the founder of Hulbert Financial Digest in Chapel Hill, N.C. He has been tracking the advice of more than 160 financial newsletters since 1980. Follow him on Twitter@MktwHulbert.
No comments:
Post a Comment