Is There Any Truth to These Investing Superstitions?

It's that time of year when a certain group of people begin to obsess over what a bunch of highly variable numbers really mean. No, I'm not talking about political junkies and their polling horse races. It's time to bring out the wacky stock-market indicators again!

Did you know that short skirts portend big gains, or that the beat of popular music can predict market volatility? These are just a couple of the many strange market indicators cooked up by bored analysts and underworked academics over the years. Many are esoteric and difficult for ordinary investors to measure, but there are a few that rely on good old-fashioned "if-then" clauses: If one of two possible options is true, then the market will rise; otherwise, look out below!

Yahoo! Finance's Daily Ticker jumped into this pseudo-prediction arena a couple of weeks ago by claiming that stocks should rise in the fourth quarter because the president's re-election chances were looking very good at the time. "According to the Stock Trader's Almanac," claims the Daily Ticker, "stocks have advanced in every fourth quarter since World War II (excluding 1948) when an incumbent president wins the election."

I'll put this prediction to the test further into this article, but I'd also like to talk about a couple of "indicators" that you're sure to hear about early next year: the Sports Illustrated Swimsuit Indicator and the Super Bowl Indicator. The next time a gullible friend greedily predicts big gains because his favorite team won the big game, you'll be able to explain the truth behind the numbers. Or you can just laugh, but at least you can laugh with knowledge on your side.

A little too revealing?
The stock market has seen more than its fair share of superstitious traders. Many of them are chart watchers or "technical analysts" who live in fear of the death cross, despite the fact that the evidence simply isn't on their side. But, if nothing else, these technical signals are directly related to what goes on in the stock market, which is hardly the case for our three wannabe indicators.

Take the SI Swimsuit Indicator. It's a creation of the Bespoke Investment Group, which claims that "U.S. equity markets perform better in years where an American appears on the cover of [Time Warner's (NYS: TWX) ] Sports Illustrated" for its annual swimsuit issue. But there's a caveat: The indicator only works from 1978 onward. If you examine the S&P 500's (INDEX: ^GSPC) annual returns from 1978 to 2011, years with American cover-models outperform those with foreign models by 3.5%.

Restricting this indicator to the late 70s and onward makes no sense when the SI Swimsuit Issue has been published since 1964. I tracked down the nationality of each year's models from the very beginning, including years in which there were multiple swimsuit models. (It was no easy task, but the pursuit of truth demanded an exhaustive search!) Accounting for proportional representation on multiple-model covers, the S&P grew only 0.8% more in years when Americans graced the cover than it did in all other years. The S&P 500 was even somewhat less apt to grow at all in American-model years, in which 21 of 27 years saw positive returns, versus 22 of 25 foreign-model years.

I think we can safely discard the Swimsuit Indicator, although you're welcome to use it as an excuse to "research" classic bikini photos. That one was easy enough to disprove, but what about the Super Bowl Indicator?

Super Bowl shuffle
This one is a little harder to rebut. The Super Bowl Indicator has been surprisingly accurate since its genesis in the 70s. If a team from the original National Football League wins the Super Bowl, the Dow Jones Industrial Average (INDEX: ^DJI) will supposedly have a positive return for the year. Should a team that got its start in the pre-merger American Football League win the big game, you'd better stay on the sidelines. Since the Packers won the first Super Bowl in 1967, this indicator has been right 80% of the time. AFL teams have won 11 times, and six of those years saw market declines. Old-school NFL teams have won 35 times, and the Dow advanced in all but four of those years.

Achieving that level of accuracy by chance is about 0.002% if each team has a 50-50 chance of winning and every year hosts an AFL and an NFL team on opposite sides of the field. However, that's hardly the case. A Snopes page devoted to the Super Bowl Indicator points out that "due to league expansion, franchise moves, and conference shifts, the [indicator] has posted some interpretive problems. ... Both the 2003 and 2004 championship games featured post-merger expansion teams ... and the 2007 and 2009 contests were waged between two original NFL teams."

It's also worth considering that the pre-merger AFL had only 10 teams, while the modern NFL has 32. Old-school AFL teams, therefore, should have just under a one-in-three chance of making the Super Bowl in any given year. Instead, they've made it to 31 of 46 possible Super Bowls and have wound up with a rather pitiful overall Super Bowl win percentage of just 35%. Outperformance in getting there led to underperformance in the big game, so the Super Bowl Indicator has shown surprising accuracy because AFL teams keep choking when it matters.

In an alternate universe where the Buffalo Bills won the four Super Bowls they lost in the early 90s, no one talks about the Super Bowl Indicator. In that universe, buying the Dow based on the Super Bowl Indicator (only on NFL-winning years) with an initial $10,000 investment from 1967 onward would lead your portfolio to underperform a buy-and-hold index investor by more than $100,000.

Vote for your portfolio
The Super Bowl Indicator took some work to debunk, but the Daily Ticker's fourth-quarter incumbent-victory indicator is the easiest of the three to disprove. They even give you a clue right in the claim. Why is 1948 an exception? The Dow declined in the fourth quarter (and the full year) of Truman's unexpectedly successful re-election campaign. However, this indicator doesn't even hold up for many incumbent victories, including for those occurring after 1948. LBJ's landslide victory in 1964 came despite a slight drop in the Dow during the fourth quarter -- although it did finish the full year with a 14% gain. The Dow avoided a decline during Reagan's re-election by only the slimmest of margins, and the index closed out 1984 with a full-year loss.

The Dow's movements during the fourth quarter of a re-election campaign actually hold little sway over its outcome, and vice versa. FDR's 1940 re-election occurred despite fourth-quarter and full-year declines. Wilson's 1916 victory saw similar circumstances. Since 1900, there have been 13 successful re-election campaigns, and four of them happened despite stock market weakness. In those 13 campaigns, the Dow has gained an average of 6.3% in the fourth quarter against an average of just 2.5% for all fourth quarters, but that outperformance is skewed by two huge year-end market rallies at the turn of the century.

Closing thoughts
It's easy to find clever theories on why the market will (or did) move in a certain direction, but nearly all of them fail or fall short by trying to connect well-known responses to earnings and valuations with unrelated trends. Earnings and valuations matter. Growth matters. Profitability, cash flow, and business opportunities -- these things all matter a great deal when investing. Sports championships? Not so much. Presidential elections? Even though we make a great deal of the market-shaking potential of its outcome, a campaign doesn't require strong market performance to succeed, nor does the market require a victorious incumbent to do well.

If you had followed any of these indicators, buying and selling Coca-Cola (NYS: KO) shares based on what the market was supposed to do, your total long-term returns would have been significantly lower than those earned by simply holding the shares and collecting thousands upon thousands of dollars in dividends over the years. If you had bought Monster Beverage (NAS: MNST) when it was tiny Hansen Natural a decade ago but sold in 2004 when both the Swimsuit and Super Bowl Indexes warned of tough times, you'd have missed out on an annualized growth rate of 58% over the following eight years. Then again, if you had paid attention to the fundamentals behind either stock, you would have found little reason to part with your shares, no matter what was happening with any given indicator in any given year.

Question everything and focus on the fundamentals. In the end, that's all that matters.

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Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more news and insights.Motley Fool newsletter services have recommended buying shares of Monster Beverage and Coca-Cola. The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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