Tuesday, April 1, 2014

Don’t worry about the dreary first quarter — yet

By Mark Hulbert

Stock market bulls are certainly hoping that the past is not prologue. The Dow Jones Industrial Average /quotes/zigman/627449/realtime DJIA +0.39%   actually fell slightly for the first quarter ( down 0.7%), even though the S&P 500 /quotes/zigman/3870025/realtime SPX +0.41%  and the Nasdaq Composite /quotes/zigman/12633936/realtime COMP +1.15%   were able to eke out a miniscule gain. A flat 2014 would be a big disappointment, following the market’s double-digit percentage increases in each of the previous two calendar years.

Fortunately, the historical data do not show any significant correlation between the market’s performance in one calendar quarter and its subsequent performance. At least that is what I found upon feeding into my PC’s statistical software the Dow’s quarterly returns back to its creation in 1896.

Average second quarter DJIA gain
Average DJIA gain last 3 quarters of year

When DJIA gains in first quarter

When DJIA loses in first quarter

As you can see from the table, the DJIA’s second-quarter gain is slightly better following down first quarters than when it rose during the first three months of the year. Note carefully, however, that the difference is not significant at the 95% confidence level that statisticians typically use to determine if a pattern is genuine.

In other words, a great second quarter is just as likely following a down first quarter as it is following a fabulous one.

The same statistical conclusion applies when we focus on the last three quarters of the year.

Consider the four other occasions over the past half century in which the Dow — like this year — lost less than 1% during the first quarter. In two of them the Dow rose during the second quarter, and in the other two it fell. Over the last three quarters of those four years, the Dow’s direction was also equally split — up in two and down in two.

These results constitute yet another victory for the efficient market. The stock market’s level at any given time reflects all available information at that point.

So in coming months the stock market will rise if the news is better than expected, fall if the news is worse, and be more or less flat if things work out as the market currently expects.

The situation is no different now than at any other time, in other words.

And while we might think we’d like it if the stock market were more predictable from quarter to quarter, you should be careful what you wish for.

If the market’s return on a given quarter were related to how it did in the previous one, then the market would suffer from “unnecessary and unhealthy turmoil,” according to Lawrence Tint, a chairman of Quantal International, a firm that conducts risk modeling for institutional investors. In an interview, he said “We can be comforted by the fact that reasonably efficient markets always base their level on anticipated future returns, and do not include history in the calculation.”

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