History Predicts The S&P 500 In 2014 Will Be ...

| About: SPDR S&P (SPY)

What can the first two months of the year tell us about what to expect in 2014 for the S&P 500 (NYSEARCA:SPY)? This article answers that question by looking at the historical monthly returns of January and February both separately and combined. In addition to these, a two-month return is calculated and the forecasting ability for the full-year is put under the microscope. The time period under study is 1950-2013 and data for the S&P 500 refer to Bloomberg ticker symbol SPX Index.

The common saying is "As January goes, so does the year". (First identified by Yale Hirsch of the Stock Trader's Almanac). How helpful is this saying? To achieve the full benefit of this, we need to dive into the numbers. Overall the January Barometer has been correct 76.6% of the time. That means when January is up, the year will be up and when January is down, the year will close down and this occurs almost 8 times in 10. If we break down the predictability to positive and negative Januaries then we see a different statistic. When January is up (40 times in the last 64 years), the year is up 90% (or 36 times). However when January is down, as has just occurred, the year is down only 54% of the time (13/24). When January has closed down, the average yearly return for the S&P 500 was -4%. Therefore while an up January can give us confidence, a down January really doesn't mean much.

Let's look at a 'February Barometer'. Overall, February has been correct 65.6% of the time. In the 35 years February has been up, the S&P 500 closed up 30 times or 86%. In the 29 years the month has been down, the year closed down 12 times or 41%. When February has closed up (just like this year), the average yearly return for the S&P 500 was 14%. So far in 2014, we have a January which was down which means a 46% chance the market will close up for the year, and February is up which means an 86% chance the market will close up for the year.

Now, let's combine both January and February together. We have four permutations:

  • Up January, Up February (Up, Up)
  • Up January, Down February (Up, Down)
  • Down January, Up February (Down, Up)
  • Down January, Down February (Down, Down)

Starting at the two extreme scenarios "Up,Up" and "Down, Down" we noticed that predictability is much stronger in the first case. When both January and February were both up, the S&P 500 closed the year up 25 out of 26 times for an hit rate of 96%. However, when both months were down, the market closed down 60% of the time (9 out of 15 years). When January has been up but February down, then the full year ended in the positive 79% of the time (11 out of 14 years).

2014 is scenario number three: "Down January, Up February". This scenario has occurred only 9 times in the last 64 years. Out of these 9 times, the market closed up 5 times (or 56%). The maximum and minimum returns were 13% and -12% respectively while the average and median returns were -1% and 0% respectively.

An alternative approach is to look at the return on the S&P over the entire two-month period rather than each month separately. This could be the first time ever this statistic has been studied. Overall, this statistic has been correct 73,4% of the time. However, historical results show that when the S&P was up at the end of February versus the end of the December (the previous year), the market closed up 94% of the time (in other words 34 out of 36 years). This is a stronger observation than the "Up, Up" scenario as we have 36 observations versus only 26 for "Up,Up".

With the S&P 500 about to close today (February 28th) above the December 31st level of 1,848.36, investors can rejoice and look forward to another positive year. Notice that in the 2 years the two-month forecast was wrong, the one year recorded a -0.003% return (2011), and the other year recorded an only -1.54% return (1994). The average return has been 19% with a maximum of 45% and a minimum of -2%.

So to answer the question posed in the title, history overall looks good for the S&P 500 that should close in the positive, based on the statistic (the two-month period) which has the most observations. On the other hand, mathematicians will argue that all this is just a coincidence and that there is no real correlation as only the positive periods have high predictability. Very true. I can't argue with that, however at the same time I can't help but feel good with this fun exercise.

Summary for 2014:

  • January down resulted in 46% of the time the market closing the year up (24 observations)
  • February up resulted in 86% of the time the market closing the year up (35 observations)
  • Combo: January down & February up resulted in 56% of the time the market closing the year up (9 observations)
  • First two months of the year up (End December - End February) resulted in 94% of the time the market closing the year up (36 observations)

I wish you all the best for your portfolio in 2014.

Disclosure: I am long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.