Do you want to know how stocks—as measured by the S&P 500—might perform this year? A widely followed market theory, the January barometer, claims that as January goes, so goes the year. Of course, that’s not always the case. In 2016, the S&P 500 gained 11% for the full year, after losing 4% in January. So, does this year’s 2% January gain point to an up year for stocks?
Interestingly enough, while a down January has not been a reliable predictor of an overall weak year, an up January has generally been bullish for stocks. In fact, the January barometer has held true 37 of the 39 times since 1950 when January experienced market gains.
Of course, historical trends are not a guarantee of what will happen in the future, and there are a myriad of other, more important fundamental factors to consider, including earnings strength, as well as fiscal and monetary policy, among others.
A bullish start is the stronger predictor
Why might up Januaries be better predictors than down ones? One reason may be the historical proclivity of stocks to rise. Stocks have finished higher in all but 14 out of 67 years since 1950. So, the fact that stocks finish higher for the year so often after both a positive and negative January may simply be the result of this directional bias.
There is a very strong correlation between positive January S&P 500 performance and positive market performance for the entire year. Says Jeffrey Todd, technical analyst with Fidelity: "Only during two years have stocks dropped sharply (a price decline of more than 10% for the full calendar year) after a positive January, with both instances occurring at the end of powerful multiyear market advances (1966 and 2001)."
"Moreover," Todd says, "a down January is not a reliable predictor of a weak year overall. Going back to 1950, in twelve out of 26 years when January finished in the red, the stock market actually ended higher, and often by a very substantial amount.”
Momentum is one possible reason that positive stock performance during January may actually be a reliable predictor for full-year performance. If the market gets off to a good start, a bullish trading pattern can form, and that can help fuel continued positive performance, at least through the early months, as investors jump on the trend. From a historical perspective, there is no clear evidence as to why a negative start does not more strongly imply a negative year, compared with the high correlation of a positive January translating to a positive year.
First five days
Some proponents of the January barometer also believe in the “first five days” theory, which predicts that the first five days of January will point the way for the rest of the year. The first five trading days of this year saw U.S. stocks add 2%, pointing toward a potentially positive year for the market, according to this indicator. In 2016, stocks shed 4.8%, the worst start ever on record. That ended up not being predictive, as stocks rebounded by year end. By contrast, 2015's first five days saw stocks gain 0.7%, which was not far off from the 1.4% full year gain. Thus, recent results for the first five days theory have been a mixed bag.
One problem with this theory is that the sample size of trading days is small (5), compared with the January barometer (typically about 20), to be a reliable predictor of the rest of the year. Given the small number of trading days associated with the first five days theory, there does not seem to be enough time for momentum to become a significant factor.
While it is impossible to predict the future, proponents of the January barometer think this indicator may provide some indication of how stocks will perform. Indeed, according to the 2017 Stock Trader's Almanac, this indicator has a 75% accuracy ratio since 1950. However, as previously mentioned, some of the evidence is not entirely conclusive. Additionally, this may be an unusual year, given some of the policy uncertainties in the U.S. stemming from the new administration.
Yet many investors like following the January barometer because it provides an easily identified outcome. However, crafting a strategy solely on this theory is not prudent, even after an up January.
Past performance is no guarantee of future results.