The Stock Market's “First 5 Days” Indicator? Here's the Truth, for Better or Worse.

The first five trading days of the new year are officially in the books, and, so far, so good. Despite the rough start, Friday’s big jump and a palatable start to this week mean the S&P 500 was up 1.4% for the five-day span.

And that’s got many investors excited. See, the gain theoretically points to continued bullishness for the remainder of 2023. The underlying axiom is called the “first five days” theory, which assumes investors tip their hands early on in the calendar year.

The thing is, you may not want to have too much faith in this premise.

Image source: Getty Images.

The “first five days” theory

It’s not a complicated idea. Indeed, it really is as simple as described above — if stocks end the first five trading days of a new year with a gain, the market should see net gains over the course of the 12-month stretch.

There’s seemingly ample evidence backing the theory up, too. Since 1950, the S&P 500 has logged net gains during the first five days of the year a total of 47 times. Of those 47 instances, the index ended the year up in 39 of them. That’s an 83% success rate for the first five days theory.

Don’t get too excited just yet, though. Of the 73 total completed years since 1950? The S&P 500 has logged a full-year gain in 73% of them. That may well be just because stocks are intended to rise, reflecting perpetual growth of the global economy despite the occasional stumble.

This reality becomes plainly evident in the data most fans and followers of the premise often choose to ignore. That’s its failure rate as an indicator for bearish years. In the 26 years stocks lost ground during the first five days of the new calendar year, the S&P 500 went on to log full-year gains in 14 of them anyway. The indicator only boasts a 46% success rate when it comes to predicting full-year losses.

Translation: The two calendar-based time frames considered by the first five days theory aren’t as closely tethered as some investors want to believe. Its seeming success rate as a bullish indicator may mostly be rooted in the fact that stocks just rise more than they fall.

It’s also worth noting that some of the market’s very best years since 1950 got started on a bearish foot. As an example, the S&P 500 rallied 21% in 1991 despite losing 4.6% of its value during the first five days of that year. Conversely, despite rising 1.1% over the first five days of 2002, the S&P 500 went on to lose more than 22% that year. When the theory is wrong, it can be really, really wrong. 

Focus on the fundamentals

Don’t misread the message. Any information that helps you better define your odds of driving gains or suffering losses is useful, even if it’s only a small edge.

In this case, however, the information is woefully incomplete. There’s much more data out there beyond the first five days theory to consider right now. Factors like inflation, interest rates, geopolitical turmoil, broken supply chains, and a slowing economy are in play. It’s quite possible these factors could evolve — or devolve — later this year and push the global economy into a recession, prompting a sell-off that defies the first five days axiom. The experts just don’t know.

What savvy investors do know is, given enough time, quality shines through. 

So, those are your continued marching orders as an investor. Buy quality names you’re comfortable holding onto for at least five years even if the economy tanks. As was noted, economic weakness (and any bear markets corresponding to it) tends to be relatively short-lived; there’s also the distinct possibility that a high-quality stock will be able to shrug off market-wide weakness anyway. Thinking along these lines also gives you the mental flexibility you need to make important decisions in the middle of the year, when the situation may well start to change. 

Bottom line? The calendar-based timing stuff makes for interesting reading, but it’s not a replacement for common sense. Indeed, even your gut feeling about the current economic backdrop may be a more meaningful guide right now.

James Brumley has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.