Originally published in The Papyrus, Spring 2002. A Publication of Hermes Econometrics

Market Mythology and Econometrics

Theories predicting the direction of the stock market have been popular since stocks were traded under the buttonwood tree, on a street in lower Manhattan, which eventually became Wall Street. Some theories include: the Super Bowl Theory, the January Theory, and the Hemline Theory. At this time, we have the unique opportunity to review these theories underway or mid-year.

The Super Bowl Theory simply correlates market success to the outcome of the Super Bowl. If a team from the former American Football League wins the game, the market will go down. If a team from the former National Football league wins, the market will go up. This correlation has been correct 29 out of 35 years, for an 83% success rate. However, it has been wrong three out of the last four years. This year New England won against the Rams. According to the theory, we might experience another year of negative performance. However, since New England is an expansion team and was never part of the former American Football League, it is not clear how this win affects the prediction of this theory.

The January Theory suggests that the way the market performs in January predicts its direction for the rest of the year. Since 1950 the January Theory has been correct 45 out of 51 years. In January 2002 the Dow Jones Industrial Average closed down 1%. Based on the January Theory, the market will close lower this year.

The Hemline Theory predicts that the stock market will follow the direction of women’s dress hemlines. If fashion dictates shorter skirts, the market will close up.

Hermes Econometrics bases investment decisions on an econometric model. The model does not care if hemlines are going up or down, who wins the Super Bowl or the Kentucky Derby. It monitors daily and intermediate trends in the market. Hermes Econometrics manages client portfolios based on when it is advantageous to be invested in equity markets, and when it is advantageous to be invested in money markets.

The Econometric approach worked well in 2001. MoniResearch calculates Hermes Econometrics Nasdaq returns at 17.7%, incurring fees, while Nasdaq itself returned 21.0% during the same period. For more information, see the MoniResearch article.