Following a down January
on Wall Street some dismiss
adage that year will be bad

NEW YORK » An old Wall Street adage holds that January's trading dictates the market's direction for the rest of the year, but most professional investors think there's still hope for 2005 even after the lackluster performance of the past month.

The indicator known as the January Barometer has predicted the market's performance with a startling 91 percent accuracy, but it's not infallible. Since 1950, January has ended with a loss 20 times; in 12 of those cases, the year closed lower, but the rest of the time returns were flat to higher. What does that prove? Some say absolutely nothing.

"Statistical correlations by themselves are meaningless. Too much can happen in a year for the movement of stocks in January to have any significance," said Ken McCarthy, chief economist with vFinance Investments. "You can find a relationship with a lot of different things."

Statistics professors might discount such connections, but investors follow them with something akin to a gambler's superstition. Some may secretly believe in the "skirt length theory," which says shorter skirts are a sign the market is on the way up, while longer skirts are a more bearish signal. Others have total faith in the Super Bowl Indicator, which theorizes that a winning team from the old American Football League portends a down year for stocks, while a victory for a team from the old National Football League foreshadows a bull run. (Sports buffs, take note: Whatever league the winning franchise was in when the AFL and NFL merged in 1970 is the league that counts for purposes of this indicator).

While the Super Bowl Indicator has a startling 80 percent success rate, it holds little weight with analysts who remain stubbornly focused on market fundamentals. Most believe the economic environment remains favorable, and though corporate profits may be slowing, they're likely to stay positive in 2005. This is partly due to robust consumer spending and rising business investment.

The biggest negative for stocks is the fact that interest rates are on the rise. But the market has been reassured by the central bank's measured pace of tightening, and rates remain low by historical standards -- low enough, some would argue, that they're unlikely to significantly hinder economic activity. The Federal Reserve is widely expected to raise short-term rates another 0.25 percentage point at the close of its next meeting on Wednesday. That would bring the federal funds rate -- the rate banks charge each other on overnight loans -- to 2.50 percent.

Another piece of trading floor lore that has proved less than prescient this year is the January Effect, the bounce frequently seen in small-cap stocks during the first month of the year as investors re-establish positions given up in December due to tax-loss selling. But after two robust years for small-caps, tax-loss selling was limited. Investors maintained their holdings through the end of the year, then rushed to collect profits in January, sending the Russell 2000 index of small-cap stocks down more than 6 percent.

"I'm referring to it this year as the 'January Defect,"' said Bryan Piskorowski, market analyst at Wachovia Securities. "The profit-taking seen in small-caps this month has clearly contributed to the softness in the overall market in January."

Given the fact that most of 2004's upward move came during a relatively short period, in the final quarter, January's performance should be taken with a certain grain of salt, Piskorowski said. The minutes of the Dec. 14 Fed meeting, released Jan. 4, also helped raise the anxiety levels; the Fed governors expressed concern about possible inflation, which some economists perceived as a hawkish signal.

"We came into January with a full head of steam, but not a whole lot of gas to work with," Piskorowski said. "Overall, January was somewhat of a disappointment. Having seen that big run up in the fourth quarter, I'm not too surprised to see consolidation in the first month of the year, and I am somewhat hopeful that since we haven't had any major breakdowns, that the market is basically working off its overbought condition."

There's little in the way of fundamentals standing in the way of a move higher, Piskorowski said, but sentiment remains somewhat bearish. Earnings for the fourth quarter have been strong, but have done little to boost stocks.

Since January was far from typical, all bets are off for February, which has historically been one of the weaker months for stocks. Last year, investors hung back until after the presidential election. The market has no such hurdle this year, but it also lacks a catalyst to spur buying. A sharp drop in oil prices would help; so would better-than-expected business spending or an increase in merger and acquisition activity. Barring that, investors may be facing more of the same for some time to come.

"I think that the tone being set here is something investors are going to pay attention to for a while, until you get something that changes the tone," said McCarthy, of vFinance. "Right now the tone is definitely cautious. Buyers are quick to take profits and they are not willing to stay with a position if its turning against them. To get the market going again we need something to change this current psychology."