’The expression "January Barometer" refers to the theory that the market's performance during the month of January sets the stock market's direction for the year! Therefore, if the indexes are up at the end of January compared to the beginning of the month, proponents would expect the stock market to rise during the rest of the year. In other words, a positive January leads to a positive year, and a negative January sets the tone for an underperforming year.’
January 31, 2012
The January Barometer also includes an early warning system that suggests the first five days of trading indicate the direction of the market for the year. According to the Stock Trader’s Almanac, this early warning system has been accurate thirty-three times over the past thirty-eight years, an 86.8% success record.
All the major indexes showed gains in the first five trading days, ranging from 1.43% on the Dow to 2.74% for the NASDAQ Comp. It gets even better when the first five day indicator comes in an election year, which has a 13-2 record. Although in this era of unprecedented government intervention, extraordinary volatility and voodoo economics, investors should be as conservative as possible and take the least amount of risk possible to get the returns they need.
If the January effect was working so well, can we hope for the January Barometer to work too? The January Barometer is a theory, popularized by market analyst Yale Hirsch, that market action in January presages the direction of the market for the full year. Obviously, January is part of the year it supposedly predicts. So a better question is how well does January predict the next 11 months?
The Dow Jones Industrial Average and the January Barometer
The data below for the Dow Jones Industrial Average (DJIA) since 1950 suggests there is something to the January Barometer. When the Dow is positive in January, then the rest of the year is positive 83% of the time, averaging additional gains of 9.59%. Compare that to the Dow's performance when January is negative. In those years, the February-December returns are positive just half of the time, with an average gain of 2.04%.
This current month has been a particularly strong January. In the past, when January is up or down more than 3.5%, the "barometer" phenomenon is even more pronounced. The bottom of the table shows that when the Dow is up big, then the average return for the rest of the year is over 11% -- but if it's down big, the average advance is only 0.32%.
The January Barometer and the Effect on February
For many traders, 11 months is a pretty long holding period -- so let's take a shorter-term perspective on the January Barometer. Below is a table showing how the Dow fares during the month of February in relation to January's price action. As can be seen with the full-year results, a positive January typically leads to a positive February. When the Dow closes higher in January, February goes on to average a return of 0.57%, and is positive 63% of the time. When January is negative, February is negative more than half the time, and averages a loss of more than 1%. However, an outsized return in January has not necessarily translated into a bigger return for February. If January is up more than 3.5%, the average February gain is not as big as if January is simply positive.
The January Barometer and Individual Stocks
By breaking down the January Barometer to an individual stock level, and specifically looking at the number of times since 2000 that a stock's return in February followed the same direction as January -- in other words, the number of times January was up AND February was up, or January was down AND February was down – a definite pattern can be realized.
Below are all the stocks where January predicted February's direction at least 80% of the time. By also including the average return for each stock in February, and the percentage of the time it has been positive since 2000 -- looking at the top two stocks on the list -- Avery Dennison (AVY) and Travelers Companies (TRV) -- the February return followed suit with the January return 11 out of 12 times (92%). So far this year, AVY is up and TRV is down. If we expect this pattern to repeat, then AVY will go on to have a positive February, and TRV will suffer a negative February.
January has more stock-market lore associated with it than any other month, except perhaps October. While October is infamous for market crashes, January has a better reputation, resting in large part on the so-called January Effect and the January Barometer.
The so-called January Effect and January Barometer are a confluence of three separate effects:
• Stocks in general tend to rise in January, perhaps because of pension-fund flows or new-year optimism.
• Small stocks often do well in January.
• Stocks that suffered big losses the year before frequently spring back to life in January. This is a tax-driven effect. People sell in the old year to take tax losses. Bargain hunters swoop in as the New Year starts.
We also see a lot of things combine in the month of January:
• The State of the Union Address,
• The new Congress taking off,
• Congress re-convening.
• There’s also a lot of forecasting taking place on Wall Street.
It’s really an indicative month!
All of these effects have been working powerfully in early 2012.
It is possible that the January Barometer will be right this year -- the stock market will show a net gain for the next 11 months, mostly because the U.S. is in a recovery driven by the natural cyclical forces of the economy – particularly with jobs increasing.
Probably expect stocks to drop with a thud sometime during the year as investors watch the usual wrangling of Congress trying to achieve a budget that is reasonably in balance. There may be one or two more European debt scares too, plus the usual uncertainties of an election year.
Those problems will probably cause some declines, but with luck on our side, for all of 2012 the advances will outweigh the declines. Economic improvement, low interest rates and moderate stock valuations are a powerful combination.