Some believe that January is a good predictor for the rest of the year in the stock market. If January is up, the year will likely be a good one, if January is down, stock returns will be weaker so the theory goes. Is there anything to this forecasting signal?
First off, it does seem that if you want a single month to predict the returns of the next 11 months of the year, then January is the best performer. Researchers have examined the numbers over the 1941-2003 period and they find that, yes, historically the January barometer has been useful and definitely better than using other months to predict returns. The paper is The January Barometer: Further Evidence by Lawrence D. Brown and Liyu Luo.
Note that the January barometer is different to the market’s potential January effect, which is about the prior year’s losing stocks seeing a January bounce.
Now, you have to be careful because January is often a strong performing month in the stock market anyway. Therefore looking at the returns for the 11 months excluding January will often be weaker precisely because an often strongly performing January is excluded. To correct for this, the researchers examine the 12 months after January.
The numbers are somewhat persuasive. Over 62 years studied, January was negative about a third of the time. In those situations, the market’s mean return (using equal-weighted NYSE stock returns) was 7.2% for the next 12 months compared to 18.9% for the next 12 months when January was positive.
The median values were 5.2% for a down January and 20.0% for an up January respectively. The Sharp ratio, as a measure of risk-adjusted return for a down January is very low too at 0.005. Therefore, the researchers recommend being in bonds rather than stocks if January is negative.
Out of Sample
Of course, that research is a little stale now, ending in 2003. Have the results since then been much different? Actually, there is now some cause for concern. 2020 had an down January as did 2021. Both were strong up years for the markets. So even though a negative January may flash a warning, looking more recently going from 1950 to 2021 in 14 out of 28 years with a down January, the stock market actually rose for the year. There’s a clear risk that the January barometer may keep you out of a positive market. Especially because over long spans of history the market has tended to rise more often than fall.
Wait and See
Whatever you think, we’ll have to wait. The January barometer for 2022 can be known just yet. The first week of January was negative, which maybe doesn’t bode well, but we’ll have to wait to see whether January ends up being an up or down month.
If January is negative, maybe it is a mild concern for markets. As a single indicator goes, the January barometer is perhaps better than many others. Still, predicting the direction of the stock market remains extremely challenging.