Two consecutive sessions of stock gains erased the worst two-day start to a year since 2000. For investors who track seasonal patterns in markets, it also pointed major indexes in the right direction.
Not only is January typically a strong month for stocks—a phenomenon known as the January effect, which some analysts attribute to investors buying new shares after tax-loss selling in December—historical data suggest this month is poised to be even better than normal. That is because it comes in the third year of the presidential-election cycle, which some analysts say is typically the best for equities.
In pre-election years since 1950, the S&P 500 index (.SPX) has delivered its best returns in January, posting an average gain of 3.9% for the month, according to Dow Jones Market Data. The broad index’s average gain for all of the Januarys since 1950 is 1%, the data showed.
Part of the reason: Incumbents typically implement new policies or push for lower taxes ahead of a presidential election in an effort to boost the U.S. economy, some analysts said.
Since 1946, the S&P 500 has finished the month higher 62% of the time and has risen 89% of the time in that span in pre-election years, according to data from CFRA Research.
One factor that could boost stocks is any thawing in trade tensions between the U.S. and China. Trade concerns have weighed on investors’ outlook for economic growth during recent market declines, and negotiators for the two countries are engaged in 90-day trade negotiations scheduled to end in March.
Signs of a strong U.S. labor market and dovish commentary from Federal Reserve Chairman Jerome Powell helped alleviate some economic concerns and powered a more-than-3% rally in the Dow Jones Industrial Average (.DJI) on Friday. Easing trade tensions could propel further gains.
The S&P 500 and the technology-heavy Nasdaq Composite (.IXIC) have climbed 1.7% and 2.8%, respectively, so far this year, while the Dow industrials have gained 0.9%.
If the U.S. and China find a resolution, investors expect trade-sensitive stocks such as industrials, which have tumbled about 17% in the S&P 500 over the past three months, to lead a relief rally. Machinery company Caterpillar (CAT) and aerospace giant Boeing (BA) have been among the hardest hit, slumping 16% and 15%, respectively, since early October.
Ed Clissold, chief U.S. strategist at Ned Davis Research Group, said he is advising clients to buy industrial stocks and other cyclical sectors such as energy, an area that typically performs well in the latter stages of economic expansions.
“The market doesn’t need a trade resolution to rally, but it certainly would be a big help,” Mr. Clissold said.
Some investors, though, are dubious the January trend will hold up this year. Congress already cut tax rates in December 2017, helping to stimulate the economy and boost earnings growth in 2018.
Carlos Dominguez, president and chief investment officer at Miami-based Element Pointe Advisors, which has $400 million in assets under advisement, remains cautious on buying industrial stocks.
“If we don’t get a deal and things turn for the worst, then those industrial names are probably going to be the first ones investors will sell,” Mr. Dominguez said.
He has also encouraged clients to be more selective when buying technology stocks. The firm recently bought shares of Facebook Inc. (FB), but he still thinks software names are pricey.
The technology sector’s forward price/earnings ratio was 15.2 as of Friday, down from 18.3 at the end of September, according to FactSet.
And stock declines in January typically don’t bode well for financial markets the remainder of the year. Since 1950, every year the S&P 500 has finished lower in January it preceded a new or extended bear market, a flat market or at least a 10% correction, according to the Stock Trader’s Almanac.
One factor that could limit gains: slower earnings growth. For the first time in two years, analysts in December cut their 2019 earnings forecasts on more than half of the companies in the S&P 500, according to FactSet. They expect earnings for companies in the index to grow 7.2% in 2019, down from their forecast of 10.4% at the end of September, the data showed.
“I still think software stocks are overvalued,” Mr. Dominguez said. “The bar for this earnings period is going to be high.”