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So goes January?

Graham Cox has written in to point out that, not only was January a losing month, but that the sell-off also breached the lows made in December. He referred me to the "December Low indicator", which figures in the Stock Trader's Almanac, a longstanding market-timing franchise.

Dow busts December's lows

This indicator is based on the insight that, when the Dow closes below December's closing low in the first quarter of next year, it is often an "excellent warning sign". "But is it even better when combined with a negative January?" Graham wants to know.

First of all, I am not impressed by the record of the "January barometer", at least when it comes to predicting down-years. In the past 85 years, the Dow has dropped 29 times in the month of January. But it has only then gone on to deliver a negative capital return in the rest of the year on 14 occasions. The average return after a down January has been a positive 2.1 per cent.

No disaster here

What about years where the Dow has breached its December lows in the first quarter of the year? I count 30 such incidents since 1928. Of these, a mere 12 resulted in negative returns over the remaining three quarters of the year. The median return overall was 3.9 per cent. Once again, I can hardly lose sleep over this.

In my experience, stitching two or more dodgy indicators together seldom results in a more robust one. This is also the case when we combine the "January barometer" and the "December low indicator". Of the 23 years since 1928 where the Dow has gone down in January and has also breached its previous December's lows, only 11 then saw losses for the rest of the year.

I dare say one could make further tweaking, such as also looking at years where the first trading week is also negative, which is what Graham suggested I do. I am all for studying seasonal patterns, but prefer them to be as straightforward as possible. The more quirky and convoluted the rules involved, the less chance that there's a good reason behind them, and thus that the quirk will happen again.

Oversold FTSE

Whether or not 2014 ends being a positive or negative year, the current sell-off in equities is nearing some interesting levels. The FTSE 100 and Dow have already reached their 200-day moving averages, while the S&P and DAX are in sight of theirs. All are also fast approaching oversold levels according to their daily relative strength indices.

S&P's past bounces

Oversoldness during a bull market typically leads to good buying opportunities. The S&P's two episodes in 2012 are a great example of this. I don't doubt we'll see a decent bounce within the next few days, therefore. And I'll happily play that from the long side. The more interesting question is whether it leads to a lasting recovery or not. My guess is that it will.