Gunner’s Note: On April 11, Mark Bail told his readers to sell their recommended CA, Inc. May 2006 $30 puts (CAQF). This transaction netted gains of 13.8% in four weeks...

Mark’s no stranger to quick gains. In one 7-month stretch in 2004, the privileged few members of his advisory service capitalized on 13 of 14 winning picks -- an accuracy rate of better than 92%. You can learn how to get in on the action here...

Today, Mark writes about what you should expect out of the equities market for the remainder of 2006. Enjoy...

The Sleuth
Is the Past Prologue?
April 25, 2006

Hello again, Sleuths,

As you may recall, earlier this year I opined that equities would have a rough time in 2006.  With almost four months of this year in the books, that prediction looks to be among my least notable achievements.  My, the market can sure be humbling!

Now, as I mentioned at the time, seer saying is not my strong suit.  I leave the predicting business to some of my Agora Financial colleagues, those whose longer-term outlooks better fit the “big picture” approach you need to have in order to successfully forecast trends and long-term market shifts. 

My specialty, on the other hand, is in discerning -- and exploiting -- short-term price movements.  That’s what I’ve done in my trading career and that’s what we focus on in MST Trader.  I concentrate on what the market is doing right now and seek to find the most profitable opportunities within that short-term environment.

So, with nearly four months of the year behind us, I wanted to get a bead on what was likely to transpire throughout the rest of 2006.  In other words, does this positive start to the year portend a solid year overall for equities?  Or do bullish beginnings frequently melt away in the heat of the summer and turn to fool’s gold by year’s end?

In order to locate some clues as to what the bullish start to 2006 portends for the rest of the year, I checked the returns in the S&P 500 for every year going back to 1970.  Permit me to share with you some of the results I found.

In the 36-year period from 1970-2005, the S&P 500 finished in the plus column on 27 occasions, or 75% of the time.  Now, that’s really no surprise.  Despite some tough times for equities in the 1970s and the rocky 2000-2002 period, much of the past 36 years has been bullish.

But nearly four months have already gone by this year.  And through Monday, April 24, the S&P 500 sits 4.8% higher than where it ended 2005.  So, while it would be great to trade the past, it’s our ability to get in step with the present and future market trends that will determine our near-term success.

So, how has the S&P 500 performed over the last eight calendar months of the year?  I went back over the numbers -- factoring out the January through April results for each year -- and studied the index’s returns from May 1 through the end of December.  And while the number of profitable May through December periods were not as great as they were for the full calendar year, the index did manage to close out the year at a higher level than where it sat at the end of April on 25 occasions, or 69% of the time.

That’s fine.  But what I really wanted to find out was if the first four calendar months tipped us off to what we should expect for the rest of the year?  Or is there no relation between the immediate past and the immediate future?  In other words, is the past prologue?

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What I found was interesting.  It turns out that, in the 36-year period from 1970-2005, the S&P 500 was able to turn a profit during the January through April timeframe on 20 occasions, or 56% of the time. 

Now, on the 20 occasions that the S&P 500 finished the first four months of the year in positive territory -- like it appears it is going to in 2006 -- the gains captured exceeded the profits that were later obtained, on a percentage basis, throughout the rest of the year.  Conversely, during those 16 years where the S&P 500 ended April at a lower level than it had started the year, the index would, on average, exceed those desultory initial four months results during the remainder of the calendar year.

So, does that mean that a bullish start leads to bearish results and vice versa?  And should I hold out hope that my earlier bearish equities forecast is likely to bear fruit?

No, no, a thousand times no!  You see, when I delved further into S&P 500’s historical results I found something quite different.  What I discovered was that the past, in fact, is prologue. 

I separated out the 20 profitable January to April periods and analyzed them separately from the 16 unprofitable ones.  I discovered that on all 20 occasions that the S&P 500 turned a profit during the first four calendar months, it ended the year in the black.  Conversely, when the S&P 500 was behind the eight ball at the end of April, it was only able to pull itself into positive territory by the end of December seven times.

Now, you may be wondering what’s so impressive about the S&P 500 turning a profit when it already has a positive head star after one-third of the year.  I know that very question crossed my mind.  So, I pushed my inquiry a little further.  I wanted to find out whether the S&P 500 was more or less likely to tack on additional gains if it was ahead after the first four months of the year.  In other words, is the past prologue?

Now, remember that in 25 of the 36 years between 1970 and 2005, the S&P 500 turned a profit between the months of May and December.  Well, in 17 of those 25 profitable May to December periods, or 68% of the time, the S&P 500 posted a profit after having already climbed higher in the prior four months. 

To understand the significance of this statistic, keep in mind that the S&P 500 was only profitable in 20 out of the 36 January to April time periods during the years 1970-2005.  What that means is that in 17 out of those 20 years -- or 85% of the time that the S&P 500 started the year in bullish fashion -- it managed to close out the year at an even higher level.  So, based upon the historical pattern of the last 36 years, it is highly likely that the S&P 500 will conclude 2006 at a higher level than it is currently trading at now.  So, yes indeed, the past does appear to be prologue.

Does that mean you should follow a buy and hold strategy for the rest of the year?  Not necessarily.  But it does suggest that -- despite rising interest rates, record oil prices, soaring commodities, and a host of other daunting foreign and domestic challenges sure to continue to worry investors -- the odds do not favor the bears suddenly seizing control of the market and driving it off a cliff.

I guess I’ll need to file that bearish prediction of mine and save it for another year.  Meanwhile, in my next column, I’ll discuss a couple of other patterns I uncovered when mining the S&P 500’s historical data.   

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Mark Bail has spent several years studying the financial market as well as running several options, equities, and mutual fund newsletters... <click here for full bio>