The first month of the new year welcomes a host of developments on Wall Street that make January an especially important month on which to keep an eye.
This article takes a deeper dive into the predictive power of January, more commonly known as the January Barometer, the nuances associated with this indicator, and how to play it with ETFs.
Be sure to read more about other historical market patterns you can trade, including December Stock Market Seasonality and the January Effect.
What Is the January Barometer?
First conceived by Yale Hirsch in 1972, the January Barometer refers to the predictive power that the first month of trading has on the market’s performance for the rest of the year. The barometer boils down to this: January’s overall gain or loss sets the tone for the remainder of the year.
In other words, if we have a positive return for the month of January, then chances are that the rest of the year will be bullish; likewise, a negative return in the first month is expected to foreshadow a bearish year in the stock market.
The premise behind the January Barometer is perhaps most succinctly described with the adage, “As goes January, so goes the year.”
There is a great video explanation from the Stock Trader’s Almanac, the authority on seasonal trading, about the January Barometer: watch it here.
Why January?
What are the forces at play that make January more special, so to say, than any other month when it comes to predicting future stock market returns? It boils down to a few key factors.
- Political: Two key political events occur every January, and once every four years in the case of the latter: New Congress convenes during the first week of the month and the Presidential Inauguration Day falls on the 20th of the month.
- Expectations Revisited: Wall Street analysts, economists, and forecasters of all stripes are expected to issue their full-year outlooks as trading kicks off in the new year. As expected, these sorts of releases tend in large part to set the tone for investors’ expectations for the rest of the year, regardless of their actual accuracy.
- Inflows & Portfolio Tweaking: The first month is also prone to seeing increased cash inflows. That, matched with investors’ tendency to rebalance their portfolios at the start of the year, are two important drivers of market direction.
The combination of all of the above factors taking place in the month of January is believed to be the fundamental driver behind the barometers’ predictive power.
How Accurate Is the January Barometer?
According to the Stock Trader’s Almanac, the barometer has around an 87% accuracy rate. Since 1950, every down January was followed by a new or continuing bear market, a 10% correction, or a flat year.
Here is the accuracy of the barometer visualized another way, courtesy of Stock Trader’s Almanac:
Key takeways:
- The stock market has an upward bias over the long-haul.
- Negative returns in January have been a powerful predictor for the market’s one-year seasonal pattern.
Risks and Other Factors to Consider
The January Barometer has registered eight major errors since 1950 through 2015. All instances when the barometer has proved inaccurate have been a result of exogenous or fundamental catalysts. For example:
- January was down in 2003 as a result of increased uncertainty surrounding anticipated military intervention in Iraq; unexpectedly so, the S&P 500 ended the year with gains upwards of 25%.
- January was a down month in 2010, however, the S&P 500 still churned a 12% gain for the year in light of increased Fed intervention fueling confidence.
Ultimately, the January Barometer breaks down when there is a big fundamental variable in play. Put another way, the January Barometer works, except when it doesn’t because of other factors. When put this way, it certainly loses some of its luster as a standalone, actionable indicator.
Ways to Play
Investors can play the domestic equity market via ETFs in a plethora of ways in an effort to trade around the January Barometer. The most straightforward approach is to tap into the major stock indexes:
For even more variety, consider the full list of U.S. equity ETFs here; this excludes actively managed, inverse, and leveraged ETFs.
The Bottom Line
As is the case with any other seasonal pattern, technical indicator, or fundamental valuation metric, it’s best if you don’t rely solely on any one of them in isolation; the January Barometer is no different. The best advice is not to define your investment allocation decisions for the rest of the year based entirely around one piece of evidence. Do your homework to have a more comprehensive understanding of all the fundamental, technical, and seasonal factors at play.
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