In our Stock Trader’s Almanac 2020, we illustrate that the January Effect, where small caps begin to outperform large caps, actually starts in mid-December, notes Jeffrey Hirsch, editor of Stock Trader's Almanac.
Early signs of the January Effect can be seen when comparing iShares Russell 2000 (IWM) to SPDR S&P 500 (SPY) since December 16. The majority of small-cap outperformance is normally done by mid-February, but strength can last until mid-May when indices typically reach a seasonal high.
The first indicator to register a reading in January is the Santa Claus Rally. The seven-trading day period began on the open on December 24 and ends with the close of trading on January 3. Normally, the S&P 500 posts an average gain of 1.3%. The failure of stocks to rally during this time tends to precede bear markets or times when stocks could be purchased at lower prices later in the year.
On January 8, our First Five Days “Early Warning” System will be in. In pre-presidential election years this indicator has a solid record. In the last 17 presidential election years 14 full years followed the direction of the First Five Days. The full-month January Barometer has a slightly softer record in presidential-election years with 12 of the last 17 full years following January’s direction.
Our flagship indicator, the January Barometer created by Yale Hirsch in 1972, simply states that as the S&P goes in January so goes the year. It came into effect in 1934 after the Twentieth Amendment moved the date that new Congresses convene to the first week of January and Presidential inaugurations to January 20.
The long-term record has been stupendous, an 85.5% accuracy rate, with only ten major errors in 69 years. Major errors occurred in the secular bear market years of 1966, 1968, 1982, 2001, 2003, 2009, 2010 and 2014 and again in 2016 as a mini bear came to an end.
The tenth and most recent error was in 2018 as a hawkish Fed continued to hike rates even as economic growth slowed and longer-term interest rates fell. The market’s position on January 31 will give us a good read on the year to come. When all three of these indicators are in agreement it has been prudent to heed their call.
