‘ Forget the “January Effect”… Use The “Siegel Indicator” Instead [ No… not that one either … he was, ie., wrong about 2011. ]

by Dr. Mark Skousen, Contributing Editor
Thursday, December 30, 2010: Issue #1418

“Be suspicious of neat systems for beating the market and formulas for getting rich.” [ Including the author’s … he was wrong about 2011. ]

– Gerald Loeb

Yet many investors are always looking for such systems and formulas in an attempt to find an edge. Here are three examples…

~ The “Dogs of the Dow”: This entails buying the 10 Dow stocks with the highest dividends. The strategy became popular in the early 1990s and worked like a charm for several years until Wall Street caught on and created investment trusts.

In addition, the system became so popular that it stopped working. And it almost collapsed in 2008, when several Dow stocks discontinued their dividends entirely (Citigroup, GM and Bank of America). Investors didn’t know what to do.

~ The Presidential Election Cycle: It’s argued that the first two years of a four-year presidential election cycle are usually the worst in terms of stock market performance. That’s because the government and the Federal Reserve attempt to rein in the excesses of the election year stimulus.

However, the third year of the election cycle (that would be 2011) is traditionally the best-performing year on Wall Street, with the election year itself in second place, as politicians try to stimulate the economy and help Wall Street.

But this didn’t work last time. The 2007-2009 bear market began in the third year of the Bush administration. And 2008, the election year, was terrible for the market, as it plunged by more than 50%. And the stock market has risen strongly during the first two years of the Obama administration, opposite of the traditional cycle.

That brings us to the third “guaranteed” moneymaking strategy – the “January Effect.”

The Theory Behind the “January Effect”

There are several variations of the January Effect…

1. Stocks tend to rally sharply during the first week of January.
2. Small-cap stocks fare better than large-cap stocks in January.
3. Stocks perform better in January than during any other month.

If there’s any pattern, the first two are the most accurate. There’s no evidence that January outperforms other months on average.

So what are the reasons behind this January Effect?”

With regard to small-cap stocks in particular, the case for a stock rally probably has something to do with the fact that…

(a) Tax-selling is especially strong on small-cap stocks in November and December.

(b) Many investors and institutions add to their positions at the beginning of the year through IRAs and trusts.

But there’s no 100%, sure-fire, market-beating strategy – and not when it comes to the January Effect. Take a look at the past two years, for example…

The “Siegel Indicator” Points to a Bullish 2011

In January 2008, stock prices were weak and the market crashed that year. But in January 2009, although stocks were weak again, the market recovered sharply from March onward. In January 2010, we saw a decent rally and the market went on to do well for the rest of the year.

So what indicator does work?

My favorite is what I call the “Siegel Indicator.” In his book, Stocks for the Long Run, Jeremy Siegel states that any time the U.S. stock market collapses by 50% or more, it rallies and then averages 20% a year over the next five years. Siegel has been right for the past two years and he’s bullish for 2011. So am I.

Good trading – AEIOU,

Mark Skousen ‘