Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
After a stellar 2013, the Dow Jones Industrials (DJINDICES:^DJI) opened 2014 on a sour note, falling 135 points in its first day of trading in the New Year. Immediately, many investors started worrying about whether the downward move was an ill omen for 2014. But before you panic about a possible correction, let's take a look at the hard numbers to see whether there's a statistically sound reason for concern.
All eyes on January
January is an especially fertile source of seasonal factors for the stock market. Many point to the outperformance of small-cap stocks over their large-cap rivals in what's known as the January effect, as relatively illiquid stocks that were victims of tax-loss selling late in the previous year often climb as investors rush in to take advantage of lower valuations.
Others look at January as a barometer for market sentiment for the remainder of the year. According to figures that S&P index analyst Howard Silverblatt gave USA Today recently, a winning January for the S&P 500 has led to a winning year almost 73% of the time. The article also cited the Stock Trader's Almanac and its finding that if you look just at the first five days that the market is open in January, positive results lead to a winning year almost 85% of the time since the mid-1970s.
The other side of the coin
Those results sound compelling. But to assess the true value of the indicators, you also have to look at what happens when the market falls over their respective time periods. The Stock Trader's Almanac argues that every time the S&P 500 has fallen in January over the past 63 years, poor results have followed, with average losses for the remainder of the year of almost 14%. Yet when you look only at the first five days of January, the market has actually risen for the full year more often than it has dropped after an early year decline.
It's easy to understand why investors are skittish about Thursday's declines. The last time that stocks fell on the first trading day of the year was 2008, marking the beginning of the huge market meltdown that accompanied the financial crisis later that year.
But you also have to remember other considerations that can lead people to sell. Those who wanted to take profits on their winning stocks had a big tax incentive to wait until 2014 began before making sales, and that likely played at least a role in the declines we saw in many of 2013's big winners. Netflix (NASDAQ:NFLX) fell about 1.5% despite seeing every sign of continuing its growth trajectory, with initiatives designed to capture as much money from streaming video as possible. Among high-flying tech stocks, Google (NASDAQ:GOOGL) and Microsoft (NASDAQ:MSFT) also nudged downward. Yet Google still has its commanding presence in online search and continues to reap new profit opportunities from it, and although Microsoft has struggled to keep up with its rivals, it has moved forward with efforts designed to help it catch up in 2014 and beyond.
In all, paying too much attention to a single day's performance simply shows the dangers of short-term thinking. Looking at short-term indicators can be interesting, but in the long run, it's essential to look past short-term effects and focus on the factors that will boost your stocks for years and decades to come.