Some believe that January is a good predictor of the stock market for the rest of the year. If January is up, the year is likely to be a good one, if January is down, stock returns will be weak so the theory goes. Is there something in this forecast signal?
Firstly, it seems that if you want one month to predict the returns of the next 11 months of the year, January is the best performer. researchers Have examined the numbers in the period 1941-2003 And they find that, yes, historically the January barometer has been useful and certainly better than using other months to predict returns. The paper is the January Barometer: Further Evidence by Lawrence D. Brown and Liu Luo.
Note that the January barometer is different from the potential January effect of the market, which is about losing stocks from the previous year given the January bounce.
Now, you have to be careful because January is often a strong performing month in the stock market anyway. So it would be weak to look at the returns of 11 months except January as the often strongly performing January is excluded. To correct this, researchers study the 12 months after January.
The numbers are somewhat persuasive. A study of more than 62 years, January was negative about a third of the time. In those situations, the market average return for the next 12 months (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.
Average prices for January declines were 5.2% and 20.0% for January ups, respectively. The sharp ratio is also too low at 0.005 as a measure of risk-adjusted return for the January decline. Therefore, the researchers recommend staying in bonds rather than stocks when January is negative.
out of sample
Of course, that research is a bit out of date now, ending in 2003. Have the results been very different since then? Actually, now there is cause for concern. In 2020 was down like January 2021. Both years were strong for the markets, So even though a negative January may flash a warning, with a recent January decline going 14 out of 28 years from 1950 to 2021, the stock market has actually risen for the year. There is a clear risk that the January barometer could keep you away from the positive market. Particularly because the market has risen more often than downturned over a long period of history.
wait and see
Whatever you think, we’ll have to wait. The January barometer of 2022 is yet to be known. The first week of January was negative, which may not be a good sign, but we will have to wait to see if the month of January turns up or down.
If January is negative, then perhaps it is a cause for mild concern for the markets. As an indicator, the January Barometer is probably better than many others. Nevertheless, it is extremely challenging to predict the direction of the stock market.