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We Have Seen the Future and It Is...

March 30, 2006 By:
Fred D. Snitzer - JE Feature
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The strong stock-market performance during the first month of the year unleashed an avalanche of commentary from prognosticators in the financial community. Peering through their financial magnifying glasses - like geekier versions of Sherlock Holmes - they look earnestly for patterns from the past to help them divine the future.

Is there a relationship, they ask, between a good first month and the rest of the year?

What about a good first month 14 months after an election year?

What about a good first month three years after the end of a recession?

As your quintessential cantankerous old-timer might say, 'Enough already'! You'll give yourself an ulcer, for God's sake!

A basic law of statistics, called the central limit theorem, states that you normally need a sample size of at least 30 before you can make any meaningful conclusions about patterns in statistics.

For example, have you ever watched a baseball game and found yourself annoyed at the motley collection of useless statistics that are thrown up on the screen to keep us entertained? You may hear an announcer say: "The statistics don't look good for Batter A, who in his five appearances against Pitcher B has only one hit, for an average of just .200."

A sample size of five is meaningless in any endeavor. What if the batter happened to be Tony Gwynn, one of the greatest hitters of all time, and he's facing a pitcher from the Phillies, and the last time Gwynn faced him he had the flu?

What if the last time they faced off, it was pouring, or the pitcher was throwing spitballs? Or what if it was simply that Gwynn had a bad night? If you increase the number of at-bats to at least 30, you'd begin to get a better sense of how well he really hits against Phillies' pitching.

You should ask similar questions when bombarded with various theories about how the market will go up because of what happened in the first month of the year or because of which division - AFC or NFC - won the Super Bowl. An endless number of these theories exist.

Let's say the financial Holmes of this world can find 30 prior years in which the market went up during January and then went up the rest of the year. This hardly makes it a convincing case if everything else is different today.

We cannot do a controlled experiment on the world.

Today, we have a different Fed chairman, a different world climate, a more integrated global community, a declining dollar, a different monetary and tax policy, potentially harmful deficits, a fully valued market, and a single party in Congress and in the White House.

If you can find prior Januarys where the market went up and all of these variables were exactly the same - and you can find this alignment of variables at least 30 times - then maybe you have something. Otherwise, you're like the sports announcers - full of useless statistics which at best are meant to entertain, and at worst to fill up time, but in neither case, really edify.

The world is a complicated place, influenced by numerous variables, which at times work together and other instances work at cross purposes.

Sometimes, one variable takes center stage, pushing others to the background.

We will know on Jan. 1, 2007, if there was any correlation between the returns during the first month of 2006 and the returns for the remainder of the year. But we still won't know if there was causation - and probably never will.

Fred D. Snitzer is chief operating officer in the investment-management firm of Prudent Management Associates, specializing in high-net-worth and tax-deferred asset management.

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