A Stupid, Lousy, No Good Indicator

If you own stocks, you better root for the Atlanta Falcons on Sunday.

Why?

Over the last 50 years, a strange market phenomenon called the Super Bowl Indicator has had an 80% success rate in determining the market’s direction.

Never heard of the Super Bowl Indicator? It’s a stock market edict predicting that if an NFC team wins the Super Bowl, the market will have a bullish year. On the other hand, an AFC Super Bowl victory predicts a bearish year for stocks.

So if you want 2017 to be a profitable year for your portfolio, you better wear black and red for Sunday’s game.

At least that’s the story being touted in all the usual suspects this week: the Wall Street Journal, MarketWatch, Forbes.

But it’s total crap.

“There are some major holes in the story behind the Super Bowl Indicator – ones that may not be apparent to most investors. Or, apparently, to journalists either,” our resident stat geek Jonas Elmerraji says. “Correlation doesn’t imply causation. In other words, just because two things happen at the same time doesn’t mean that they’re related. In the investing world, that’s one of the most important concepts to memorize.”

So we got to thinking – does it apply to the SBI? After all, an 80% win rate is pretty impressive…

Just because there’s no logical link between Super Bowl winners and market performance doesn’t mean that there’s no complex relationship at play, Jonas says. After all, incredibly successful traders have been known to look for bizarre links between outside factors in the market. Billionaire hedge fund manager Jim Simons even admitted once that his firm researched connections between sunspots and market performance. But he wouldn’t tip his hand as to what they found out…

So, with an 80% success rate, why is the SBI a bunch of bunk?

“Well, the first thing to look at is the possibility that that 80% win rate was due to luck or chance – in other words, is that rate statistically significant? On the surface, it looks that way. But here’s the clincher: Super Bowl wins haven’t historically followed a normal distribution, and neither do stock market returns,” Jonas explains

For starters, let’s look at stocks…

“We already know that markets trend,” Jonas continues. “Long-term, the stock market has a persistent upward bias. As a result, we’ve had more up years in history than we’ve had down years – so it’s statistically more likely for any random year since Super Bowl I to be a positive year.”

Now, let’s look at the NFL…

Like stock market performance, the winning conference in the NFL is hardly random. Thanks to a long NFC winning streak between the 1980s and the late 1990s (in part the result of the dominance of the Dallas Cowboys and the San Francisco 49ers franchises during that time period), NFC teams have won more Super Bowl match ups than their AFC rivals.

“As a result, it’s statistically more likely for any randomly chosen Super Bowl year to have an NFC winner just because a couple of dynastic teams happened to be in the NFC,” Jonas concludes. “For instance, the NFC won for 12 straight seasons in the stretch between 1986 and 1997, a timeframe that just happened to coincide with strong stock market performance.”

When you put those two statistics together, it’s more likely that a year will be up than down, and it’s more likely that the Super Bowl winning team would have been in the NFC than the AFC.

So the high correlation between up years and NFC wins isn’t a huge surprise after all…

More recently, there’s been much more parity in the NFL. AFC and NFC streaks have been less likely. As a result, Jonas notes, we’ll probably see the Super Bowl Indicator’s stats look less impressive as the odds of either conference claiming the Lombardi trophy evens out while the market’s expected returns remain trending higher.

In the meantime, do yourself a favor and forget about the Super Bowl Indicator.

Want a statistical market pattern that actually works?

Take a look at industrial conglomerate Illinois Tool Works (NYSE:ITW).

“This big equipment company has a seasonal pattern that kicks off like clockwork at the start of February, and hands investors average gains of 11% by the beginning of May,’ Jonas notes. “On average, this pattern has been good for 11% gains during that 70-session stretch. And it’s worked every single year since 2006. Over the longer-term, it has an 86% win-rate stretching 22 years.”

When you’re looking at statistical market patterns, it’s just as important to take a close look at what happens in the rare years when the pattern doesn’t work. For ITW, the worst downside in that stretch was a 3% loss. Not too shabby…

That makes ITW a great example of a low-risk, high-reward opportunity right now.

The price action has been looking strong in ITW in recent months – let’s leverage the stats to grab onto the trend now.
If you decide to buy ITW here, consider parking a 5% trailing stop below your entry price. That guarantees a quick exit if ITW starts meaningfully diverging from its historical pattern.

Sincerely,

Greg Guenthner
for The Daily Reckoning

The Daily Reckoning