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January Barometer - As January Goes, so Goes the Year?

Simon Maierhofer

Did you know that there are two seasonal patterns with an accuracy ratio of 90% or higher? This is no joke. The numbers don't lie, but there is one caveat.The January Barometer has a 90% rate of success. The essence of the January Barometer is simple, as January goes, so goes the year. If January is up, the entire year will be up and vice versa.90% Accuracy - Too Good to be True?From 1950 to 2008 this pattern has played out most of the time. There were only five times when it outright failed and seven times when it wasn't exactly accurate. According to the Stock Trader's Almanac, the Barometer has a 90% accuracy ratio. In terms of odds, that's about as good as it gets.However, the January Barometer led investors in the wrong direction in 2001 when the S&P was down a full 13% at the end of the year after being up 3.5% in January. Again, there was a major misfire in 2003 when the S&P finished with a 26.4% gain after a 2.7% January loss.There was a minor misfire in 2005, but the Barometer couldn't have been more wrong in 2009 and 2010. In 2009 the S&P was down 8.6% in January but ended the year with a 23.5% gain.  After a 3.9% January loss last year, the S&P (SNP: ^GSPC) finished with a 12.6% gain.It seems like the January Barometer has lost its mojo. In fact, five hits and five misses bring the last decade's success rate down to 50%, in line with random odds.A New January PatternEvery January is different, but over the past three years a new pattern has emerged. Christmas euphoria is followed by a New Year hangover. Let's see what the numbers say.On December 24, 2007 I was invited to share my 2008 outlook with CNBC's Maria Bartiromo. At the time, the major indexes had just recovered some of their initial October/November losses and the percentage of bullish advisors polled by Investors Intelligence was 54.9%, very close to last week's 55.6%.My advice then was to employ strategies that benefit from a topping market.  On December 24, 2007, the DJIA (DJI: ^DJI) closed at 13,549, the S&P (SNP: ^GSPC) at 1,496, the Nasdaq 100 (Nasdaq: ^IXIC) at 2,128, and the Russell 2000 (NYSEArca: IWM - News) at 794.Stocks (NYSEArca: VTI - News) suffered from topping action throughout 2008 before delivering a year-end rally. In fact, the 2008 Santa Claus Rally delivered the highest return in decades, 7.4% for the S&P.On December 14, 2008, I cautioned via the ETF Profit Strategy Newsletter: 'Optimistic sentiment, which should be more visible above Dow 9,000, will give way to further declines. These should draw the indexes close to or below their November 21st lows of 7,445 for the Dow and 740 for the S&P.' Early January 2008 the DJIA poked above 9,000 three times before shedding 29%.2009/2010 was not much different than the previous two years. On December 17, the ETF Profit Strategy Newsletter stated: 'The days leading up to and following Christmas tend to have a bullish bias for stocks. Nevertheless, bearish forces are becoming more pronounced and stocks are facing stiff resistance at Dow 10,500 and S&P 1,120.' That stiff resistance led to a swift 9% correction.The chart below illustrates the pattern of December rallies followed by January sell offs. Of course this new pattern might disappear as fast as it appears, but my analysis shows that January 2011 will follow in the footsteps of the three previous Januaries.Looking Beyond JanuaryLet's say we get the expected January correction, then what?We would be in a pickle because according to the long-term track record of the January Barometer, stocks should continue weak throughout the year while according to the Presidential Election Year Cycle stocks should be up.The third year of the Presidential Election Year Cycle (such as 2011) is historically the strongest of the four-year cycle. This may sound like a too good to be true statistic, but there hasn't been a major loss in a pre-election year since 1931.In an effort to get re-elected, each administration is working overtime the year before elections to buoy whatever there is to buoy in order to create a setting that's conducive to winning as many re-election votes as possible.A Premature Pop?Courtesy of the 2008 financial meltdown, the administration and the Fed were forced to open the money spigot earlier than during the average Presidential cycle. Does that mean that the stock market has peaked pre-maturely? We don't know yet, but based on current sentiment readings it's a possibility that shouldn't be ignored.Correction and Pop ProtectionSince the market's internals today are similar to what we saw leading up to the April 2010 high and the previous three January highs, it isn't a far stretch to expect a similar outcome - a swift and largely surprising decline between 9 - 29%.The S&P hasn't reached our upside target level yet, so it's best to let the current rally do its thing. Once reversal levels are reached, the proverbial air pocket that's been supporting this creeping up trend is likely to bust and result in a downward jolt.Momentum is a fickle force. Just as momentum has carried stocks higher than expected, it may drive prices lower than any of the ueber-bullish Wall Street analysts expect.Eliminating VariablesThe big question is whether the Federal Reserve and Wall Street banks (NYSEArca: XLF - News) can manage and control any sell off. It surely seems like they were able to do so in January and April of 2010. However, they were powerless throughout 2008 and had to watch the market swallow up fellow competitors.It's no secret that my personal outlook is fundamentally bearish, but with the influx of QE2 liquidity and the bullish bias of the Presidential Election Year Cycle, it's prudent to listen to the market's vital signs.The ETF Profit Strategy Newsletter continuously monitors the market's breadth in connection with important support and resistance levels. Any trend change from up to down is most likely to occur against resistance. Once a reversal is in place, it's vital to watch how the market performs at support levels of various degrees.The ETF Profit Strategy Newsletter outlines the next major resistance level along with support levels the market has established over the past weeks, months and years. Nothing expedites momentum like a break below support. We all know what momentum can do.