A dismal first half isn't always followed by a bad second half

ANNANDALE, Va. (MarketWatch) -- Is the past prologue?

We had better hope not, since the stock market over the first half of 2010 has been a disappointing performer -- falling far short of its long-term average pace of around 10% a year.

Following Thursday's decline of 146 points, for example, the Dow Jones Industrial Average is now down more than 2.6% for the year to date. If the second half of the year is just as poor for the stock market, the full year will sport a loss of more than 5%.

Fortunately, a disappointing first half does not automatically doom the second half of the year.

A clue to this comes from just anecdotal evidence. Take 2009, for example, when the market lost ground for the first six months. Yet the second half of the year witnessed one of the strongest rallies in recent memory.

To be sure, poor first halves have not always been followed by such pleasing reversals. There have been plenty of other years in which poor first halves were followed by poor second halves as well.

But the historical record shows there is a largely random relationship between the market's performance in the first and second halves of each year.

To show this, I looked at the correlations between the stock market's first-half and second-half returns for all years since the Dow was created in the late 1800s. What I found appears in the accompanying table.

At first blush you might think that these results are impressive enough to support a bet that the second half of this year will be a below-average performer. But they are not; given the wide variability in the year-by-year results, the deviations from the overall average are not significant at the 95% confidence level that statisticians use to determine whether a pattern is genuine.

	% of time Dow rises in second half of year
When Dow falls in first half of year	59.1%
When Dow rises in first half of year	71.0%
Average of all years	66.4%

This finding should not come as a big surprise, given what Economics 101 teaches us about efficient markets. If it were the case that the market's return in the first half of a year were a reliable predictor of its return in the second half, then investors would rush into the market on June 30 to buy or sell, depending on the direction of the market's year-to-date return. Investors would soon learn that they could jump the gun by acting even earlier than June 30. Eventually the historic relationship would disappear.

Though some of you might find it disappointing that the first half of this year provides very little guide to the second half, it is in fact something to celebrate. That at least is the argument made by Lawrence Tint, chairman of Quantal International, a firm that conducts risk modeling for institutional investors. In an interview, he said that the market would be "subject to unnecessary and unhealthy turmoil" if the market's return in one period were correlated with its return in the previous period.

"We can be comforted by the fact that reasonably efficient markets always base their level on anticipated future returns, and do not include history in the calculation," he added.

So, as you lay out your financial plans for the rest of 2010, make sure to keep things in perspective. And make sure you realize the consequences!

Stocks may still decline over the next six months. But if they do, that will have nothing to do with its poor performance so far this year.

http://www.marketwatch.com/story/first-half-says-little-about-second-half-2010-06-25