January Barometer: Predicting Market Performance - Explained

The January Barometer is the idea that the investment performance of the S&P 500S&P 500 IndexThe Standard and Poor’s 500 Index, abbreviated as S&P 500 index, is an index comprising the stocks of 500 publicly traded companies in the in the month of January is representative of the predicted performance of the entire year. For example, if the month of January yields positive momentum, it is said that the remainder of the year will rise as well. The opposite versa is also true. If the market performs poorly in January, it is said that the remainder of the year will do the same.

The concept of the January Barometer stemmed from a 1967 novel called “Stock Trader’s Almanac” by Yale Hirsch. It continues to be present in many people’s trading strategies.

Summary

• The January Barometer is a market theory that is considered a forward-looking indicator of an index’s annualized returns based on the momentum illustrated in the respective month of January.
• The January Barometer was first mentioned in “Stock Trader’s Almanac” by Yale Hirsch, which was published in 1967.
• The concept is best associated with the S&P 500 Index and may not necessarily be as good of an indicator on any other indices, especially equities that are not from the U.S.

Understanding the January Barometer

Traders who believe in the theory may utilize the results to forecast and time the market. Particularly, as an indicator, they may only invest in the market during times that January is up and avoid it when the month’s returns are down. It is most often connected to U.S. equities, particularly focusing on the S&P 500.

Such a belief stems from the correlation found in data the S&P 500 predicted and actual returns between 1966 to 2001. In fact, dating back to 1928, the S&P 500 was tested 91 times to determine whether there was a correlation between their annualized and respective January months.

It appeared that on those 91 occasions, the market indeed ended the year in a similar direction as the month of January 63 times. However, it is important to be aware that the phenomenon may be coincidental, as positive returns also occurred 75% of the time within the U.S. equity markets. Thus, the strategy may not necessarily improve one’s market timingMarket TimingMarket timing refers to an investing strategy through which a market participant makes buying or selling decisions by predicting the price movements of the.

Recent Example

In 2017, the S&P 500 gained 2% in the month of January. Following afterward, the remaining months generated an annualized return of 19%, resulting in an upwards trend.

Problems with the January Barometer

There are two major problems with using the January Barometer:

• The track record of success forecasts just below 70% of the time.
• There is the assumption that investors continue to hold despite the index’s drawdown.

Although the success rate is fairly high, it is important for investors to understand that using the January Barometer as an indicator should be taken with a grain of salt, as opposed to a trading principle. It is best used to gain insight into the overall market’s health. By doing so, one can maintain a bullishBullish and BearishProfessionals in corporate finance regularly refer to markets as being bullish and bearish based on positive or negative price movements.  A bear market is typically considered to exist when there has been a price decline of 20% or more from the peak, and a bull market is considered to be a 20% recovery from a market bottom. perspective and gain confidence throughout the trading year when January yields positive momentum.

Debunking Myths of the January Barometer

Mark Hulbert, the editor of the Hulbert Financial Digest, believes the January Barometer is ineffective. He states that the stock market rises two-thirds of the time, regardless of January’s performance, which ultimately makes the theory null.

Hulbert also disagrees with the point that if the market falls in January, the remaining 11 months should also fall. Hulbert looked at the returns of the Dow Jones Industrial Average (DJIA)Dow Jones Industrial Average (DJIA)The Dow Jones Industrial Average (DJIA), also referred to as "Dow Jones” or "the Dow", is one of the most widely-recognized stock market indices. from 1897 through 2008. He found that when the Dow fell in January, its average monthly return for the remaining months was 0.25%.

Rather, it’s been mentioned that market performance in December is a better predictor of the subsequent 11 months as opposed to January, while November is the third most accurate predictor. The three months with no predictive ability at all are February, August, and September.

However, it is best to remember that the January Barometer is most effective with the S&P 500, not the DJIA.

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