The January Indicator: Fact or Fiction?

"Buy a stock," advised Will Rogers. "When it goes up, sell it; if it don't go up, then don't buy it." While this advice appears ridiculous, it's little different than much of what the media touts in its search for easy solutions to market forecasting. One such widely discussed forecasting tool is the January Indicator, which suggests that the performance of the market in January can predict performance over the balance of the year. Statistical expert, Mark Hulbert, looks at the validity of that claim.

Mark Hulbert is the editor of The Hulbert Financial Digest. He is best known for his in-depth analysis of the performance of financial newsletter portfolios. Hulbert has conducted a study to verify whether or not the January Indicator has any true ability to forecast future market performance:

"We have done our own research into the January Indicator. I think you will be surprised by what we found. The January Indicator in its earliest incarnation was a simple forecast that the stock market from February to December would follow the same direction as January's. Though the model's forecasts were right about two-thirds of the time, there was less here than meets the eye. That's because a simple naive forecast that the stock market would always go up would also have been right about the same percentage of the time. Others believe that a positive January meant that the stock market would increase over the next 11 months at a faster-than normal pace. Yes, the stock market appreciates at a slightly higher rate between February and December if January is an 'up' month. But the increase is so small, that it is of doubtful statistical significance.

"This has led to yet another incarnation of the January Indicator. An 'up' January might not tell us much about the market over the following 11 months, but a 'down' January tells us a lot. As devotees have put it, January is a great 'bear catcher'. That is, if the stock market is going to decline between February and December, January's direction will provide an early warning signal that the bear is about to come out of hibernation. We tested this theory on the Dow; we had 105 years on which to study its effectiveness. We compared the stock market's average monthly return over the 11 months following a positive January with what the comparable average was following negative Januarys.

"However, we didn't stop there. If we had, we'd have concluded that January has done an impressive job of being a bear catcher. But we went further and compared January's averages with comparable averages for every other month of the year. From our results, January no longer appears to be particularly unique. We reach a similar conclusion when focusing on the difference between the market's 11-month performances following a positive and a negative month. But perhaps the most surprising result of our study is that virtually all months do a creditable job driving a wedge between decent and poor returns over the following 11 months. The only month that is unable to do so at even the 90% confidence level is February. Or, to put this conclusion another way, all months but February are able, at the 90% confidence level or higher, to forecast higher or lower returns over the following 11 months.

"So while the January Indicator receives some statistical support from our study, it is somewhat a Phyrric Victory. In the process of receiving that support, we discover not only that January is not unique as a bear catcher, but in addition that several other months do an even better job. What does this mean for investors? Not a lot. The pattern we discovered is a simple reflection of the trends that the stock market exhibits. This is why trend-following systems have been able to work over the decades. In a roundabout way, our study provides confirmation of this fact."