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A Bad Year for Markets?

After a remarkably strong performance in 2021, financial markets now seem to be coming to terms with the likelihood that fiscal and monetary policies will tighten in 2022. Though a bearish outlook may not yet be warranted, the possibility that equities could suffer a net-negative year must be taken seriously.

LONDON – Last month, I identified what I saw as the big issues of 2022, noting that I could not recall a time when there were so many sources of uncertainty, both known and unknown. The main issue was inflation, and now that we are a few weeks into 2022, financial markets appear to be worrying about the same developments that concerned me. In fact, the problems we face are becoming more straightforward – depressingly so.

To understand today’s financial-market behavior, we can turn to the “five-day rule,” a heuristic I first encountered during my time in finance, when eager analysts would grab hold of anything they thought might help them understand the complicated world of markets. The rule holds that if major US stock-market indices rise during the first five trading days of the new calendar year, markets will perform handsomely for the year overall. According to an old stock-market almanac, this had been the case 85% of the time since the 1950s. Moreover, in cases when markets were down over the first five trading days, the market went on to have a net-negative year 50% of the time.

Given that markets were down over the first five days of this month, should we worry about 2022? Or can we take comfort in the fact that, historically, stock markets have tended to rise most years? Given that US markets had a strong year in 2021 – after many previous years of growth had already left market valuations rather high – my instinct is to follow the five-day rule, even though there is no theoretical or intellectual reason why it need apply.