A bear market in stocks just became more likely

Bad news, investors: The Dow Industrials’ 300-plus-point drop Monday markedly increases the likelihood that the bull market has neared its end — if it hasn’t already.

That’s because the stock market’s performance in the first two trading days of January has a surprisingly good record of forecasting the direction for the next 12 months.

The accompanying table reflects historical data back to 1896, when the Dow Jones Industrial Average was created.

Those differences are significant at the 95% confidence level that statisticians typically use to determine if a pattern is genuine.

Furthermore, I found that the correlation with the rest of the year’s direction is higher when focusing on the first two trading days than on the first five days. That’s curious, because Wall Street has an indicator that focuses on the first five days (the “First Five Days of January Trading Indicator”) but not, as far as I am aware, on the first two days.

For the first two trading days of this year, the Dow dropped 1.8%. That’s even bigger than the 1.6% decline the Dow posted over the first two days of 2008, a fateful year that would later experience the worst bear market since the 1930s.

Needless to say, the Dow’s decrease over the first two trading days of this year doesn’t guarantee that the Dow will drop from now until the end of 2015. The statistics reported here are based on averages and probabilities. Notice, for example, that — even assuming the future is like the past — the Dow’s decline so far this year still leaves a 51% probability that the market will be up by year-end.

Last year, in fact, the Dow dropped 0.6% over the first two trading days, but nonetheless produced a modest gain from then until the end of 2014 of 8.2%.

Still, 2014 was an exception. Perhaps that’s why the market was unable to mount any serious rally at the end of Monday’s session.

 Varchev Traders

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