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Welp, so much for starting the year off right: Stocks fell right out of the gate Monday, starting 2016 with the worst opening day since 2001. Some headlines pondered what this could mean for the January Effect—the long-running belief January or its first few trading days (depending on who you ask and what makes the snappiest headline) predict the year. Others warned the drop’s apparent cause—sad Chinese manufacturing data and a wild morning in Chinese stock markets that went global—spells doom for the global economy. Both reactions are awfully hasty, in our view. Volatility is normal, and big drops aren’t uncommon during bull markets. They can happen any old day of the year, and they aren’t any more meaningful on January 4 than they are on February 28, May 4[i], August 23, November 2 or any of the 360 other days[ii] on the Roman calendar. Monday’s volatility says nothing about what stocks will do this year.
The first trading day of the year has zero predictive powers.[iii] We repeat, zero. Exhibit 1 aggregates all of them since 1929. When Day One is positive, you have a positive year about 66% of the time. If Day One is negative, you have a positive year about 64% of the time. All this tells you is stocks were positive in about two-thirds of calendar years overall. As far as predictive powers go, this is about as useful as a Magic 8 Ball. Anyone pointing to 2001 (first day down -2.8%, year down -13.0%) and 2008 (first day down -1.4%, year down -38.5%) is confusing coincidence with correlation. We could cherry-pick plenty of counterpoints to disprove their claims. Like 1991 (first day down -1.1%, year up 26.3%), 1985 (first day down -1.1%, year up 26.3%) and 1980 (first day down -2.0%, year up 25.8%).
Exhibit 1: The January Coin Flip
Source: FactSet, as of 1/4/2016. S&P 500 price index, 12/31/1928 – 12/31/2015, returns for each calendar year and its first trading day.
Some went a little more specific, pointing to some big stocks that led in 2015 (and are erroneously credited with being the only reason the S&P 500 delivered positive total returns last year) and warning their underperformance Monday is a harbinger for the rest of the market. As in, eek, now even the big guys can’t keep it up, if they’re done for, run! But one day’s price movement isn’t any more predictive for individual stocks than it is for the broader market. Consider the five companies in question: Facebook, Amazon, Netflix, Google/Alphabet and Microsoft.[iv] Out of last year’s 252 trading days, Facebook was negative on 115. Amazon had 122 down days. Microsoft had 126. Netflix, the S&P 500’s top 2015 stock, had 129. Google/Alphabet had 119. Yet all did great! The up days just had more combined heft than the down days. Tis as simple as that.[v]
As for China, things there didn’t just suddenly get worse. Yes, the manufacturing Purchasing Managers’ Indexes weren’t so hot. But this also continues a very long-running trend—a trend that hasn’t brought that long-dreaded hard landing. The Caixin/Markit PMI, which fell to 48.2 in December, has been under 50—signaling contraction—for most of the last five years now. Yet China has grown. The official PMI, which rose to 49.7 (technically signaling a more mild contraction) has hovered around 50 for over a year. Yet China has grown. Chinese heavy industry has slowed markedly, but this is largely deliberate, as China’s economic engineers are shifting the country’s emphasis from factories and exports to services. As manufacturing has slowed, services have accelerated and are now a larger share of GDP. Services are captured in China’s Non-Manufacturing PMI, which rose to 54.4 in December.[vi] This is all par for the course in China’s long, gradual, modest slowdown—a very, very well-known event that actually adds to global growth.
So why the big selloff? Again, volatility happens. Today happened to be the first day China’s new stock market circuit breakers went live, and they are some rather weird circuit breakers. Once local markets are down -5% for the day, they stop for 15 minutes so everyone can breathe. Once they reopen, if they fall further to -7%, they’re done for the day. If you have an itchy trigger finger or need liquidity, this creates weird incentives to sell as soon as that 15-minute pause ends, lest you be locked out for the rest of the day. This likely goes a long way toward explaining why Chinese stocks took just seven minutes to hit -7% after today’s 15-minute pause ended. The system was untested, people were scared, and they didn’t want to be stuck. Perhaps Chinese regulators will tweak the system so it works more smoothly. But whether or not they do, global markets are used to huge swings on China’s local exchanges, and capital controls make actual global spillover minimal. Sentiment surrounding big Chinese down days can impact stocks elsewhere, as it seemed to do today and last August 24, but again, coincidence isn’t causality.
Days like Monday are days to take a deep breath, remember the dangers of financial myopia, and keep your eye on your long-term goals and needs. Regardless of Monday’s swings, we think global stocks are still in a bull market. Enduring down days is the price we pay for bull market returns. Over time, they look like tiny blips, barely visible on a chart of stocks’ long march upward.
[ii] And every four years, 361!
[iii] Neither does the first month of the year, but there are still 18 trading days to go, so it struck us as premature to slay that false fear now.
[iv] Some have omitted Microsoft so they can use the acronym, FANG, and all the rhymes and puns that come with it.
[v] Also, these are all Tech and Internet retail stocks. Tech and e-commerce did great last year. They had a bad day today, while Energy did great. We wouldn’t urge anyone to change their outlook for Energy based on one great day—that sector still has myriad fundamental weaknesses, just as Tech and Consumer Discretionary still have many fundamental strengths.
[vi] Caixin/Markit’s Services PMI hits later this week.