Should You Believe in the January Barometer?

02/06/2014 6:00 am EST

Focus: STOCKS

Do you believe in the January barometer, asks John Burke of Wall Street Sector Selector; as he lays out the case for whether or not this indicator is reliable.

Investors and stock traders frequently watch for omens as to what the future might have in store for equities markets. Yale Hirsch of The Stock Trader’s Almanac, was the first to suggest a correlation between the performance of the S&P 500 Index during the month of January and its performance during the course of the full year. Mr. Hirsch found that since 1950, January has correctly predicted the year’s outcome with a more than 90% accuracy ratio. The so-called January Barometer is based on the premise that if the S&P 500 advanced during the month of January, the index will continue to advance through the remainder of the year.

Presently, in 2014, followers of the January Barometer are pointing out that on December 31, 2013, the S&P 500 closed at 1,848.36 and on Friday, January 31, of this year, the S&P 500 finished the month at 1,782.59. This 3.55% decline for the S&P 500 during January has led aficionados of the January Barometer to warn the rest of us that this will be a bad year for the S&P, as we will likely find it below 1,848 on New Year’s Eve.

The first thing that comes to mind for the skeptic is the possibility that 2014 could by one of those years which will fall within that 10% category when the January Barometerwas wrong. As it turns out, we need not look back very far to find some recent whiffs.

On December 31, 2010, the S&P 500 closed at 1,257.64. Subsequently, on January 31, 2011, the S&P 500 closed at 1,286.12. This 2.26% advance would have suggested—according to the January Barometer—that the S&P 500 would have advanced during 2011. As it turned out, on December 30, 2011, the S&P 500 closed at 1,257.60. As a result, the S&P 500 was virtually flat for 2011. Those who had been banking on making a big profit by following the January Barometer, could have achieved the same result by hiding the money under a mattress.

On December 31, 2009, the S&P 500 closed at 1,115.10. Subsequently, on January 29, 2010, the S&P 500 closed at 1,073.87. This 3.69% drop would have suggested—according to the January Barometer—that the S&P 500 would have declined during 2010. As it turned out, on December 31, 2010, the S&P 500 closed at 1,257.64. The S&P 500 actually advanced 12.78% during 2010. Those who had been banking on making a big profit by following the January Barometer, would have lost whatever amount they had at stake.

On December 31, 2008, the S&P 500 closed at 903.25. Subsequently, on January 30, 2009, the S&P 500 finished the month at 825.88. This 8.56% nosedive would have suggested—according to the January Barometer—that the S&P 500 would have declined during 2009. When the S&P reached the Hadean low of 666 on March 6, 2009, those who had taken bearish positions based on the January Barometer must have been feeling confident that there was no possible way that the index would make it back to 903.25 by the end of the year. Nevertheless, the Federal Reserve came to the rescue with its historic quantitative easing program and by December 31, 2009, the S&P 500 closed at 1,115.10. Thanks to the Fed’s liquidity pump, the S&P 500 skyrocketed 23.45% during 2009 and the January Barometer was wrong.

Bottom line: January Barometer enthusiasts have referenced a time frame running back to 1950 to judge the success of this metric. Nevertheless, if we limit the time frame to just the past five years, we will see that the January Barometer was wrong 60% of the time.

By John Burke of Wall Street Sector Selector

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