Do you want to know how stocks might perform this year? A widely followed market theory, the January barometer, claims that as January goes, so goes the year. But evidence reveals that’s not always the case. In 2015, stocks managed a 1.4% gain, after losing 3.7% in January. So, does this year’s 3.4% January loss point to a down year for stocks (as measured by the S&P 500 Index)?
“Interestingly enough, while an up January is generally bullish for stocks, a down January is not a reliable predictor of a weak year overall,” says Jeffrey Todd, technical analyst with Fidelity. “Going back to 1950, in twelve out of 26 weak January years, the stock market actually ended higher, often by a very substantial amount.”
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 66 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® Index performance and positive market performance for the entire year,” notes Todd. “In fact, the January barometer has held true 37 of the 39 times since 1950 when January experienced market gains.”
Only during two years have stocks dropped sharply (a decline of more than 10%) after a positive January (1966 and 2001), with both instances occurring at the end of powerful multiyear market advances.
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 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 days of this year saw stocks shed 4.8%, the worst start ever on record. In 2015, the first five days recorded a 0.7% gain, which was not far off from the 1.4% full year gain. Over the first five days of 2014, the S&P 500 lost about a half of one percent, which was not predictive as the market rebounded, gaining 11% for the year.
The problem with this theory is that the sample size of trading days is so small, compared with the January barometer, to support the statistical relationship that the first five days of January are a reliable predictor of the rest of the year. Additionally, given the small number of trading days, there is not 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 2016 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.
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, particularly after a down January. Investors should consider dedicating more attention to the factors that affect the business cycle and create trading patterns.
Speaking of the business cycle, Fidelity's Asset Allocation Research Team thinks the U.S. economy is still in the mid-cycle phase, albeit in the latter stage of the mid-cycle—which historically implies a positive backdrop for stocks.
Past performance is no guarantee of future results.