Print

Don't be Fooled by The January Barometer

 

I'm sure I don’t have to tell you that it’s been a surprising start to the year.  With just three weeks of trading under our belts, many major stock markets around the globe have entered correction (a decline of greater than 10%) or bear (a decline of greater than 20%) territory.  Markets like the US, UK and Germany are in correction territory while China, Hong Kong, and Brazil are in bear territory.  Not exactly what we were all hoping for after back-to-back sluggish years of investing in global markets. 

So what does this drop mean for the rest of 2016?  If one gets there financial insights from CNBC you might be convinced that as January goes, so goes the year.  Listening to CNBC earlier this week, the news reporters kept referring to something called the January Barometer. They reported that during the past 35 years, the S&P 500 followed January’s direction 25 times, or 71 percent of the time. 
 
It’s funny how this type of information can mislead investors into thinking January should give them information about the future direction of markets.  To the untrained eye, 71 percent is a high number, and suggests really good odds.  To the skeptic, there’s more than meets the eye.
 


First, markets have been positive more than they have been negative.  If you look at Figure 1 below, which shows the Distribution of US Market Returns, you will see that the CRSP 1-10 Index (a US equity market benchmark) has been positive 75% of the time from 1926-2014 (67 years), thus negative only 25% of the time (22 years).  I think the last 10 to 15 years of below average returns for stock markets have made investors forget that the stock market is typically a place where our money grows most of the time.

Figure 1: Distribution of US Market Returns



So CNBC's claim that market returns follow the direction of January returns 71 percent of the time refers to the combination of BOTH up and down markets and is thus distorted by equity markets having positive returns in almost all years in which January was also positive.    

The numbers below will further explain in better terms what I'm talking about.  I've looked at different indices for the longest common start date (1999), and even looked at the S&P 500 Index as a standalone going back to 1926.  The simple test was:

  • True/False:  If January is negative, is the return for that year negative?
  • True/False:  If January is positive, is the return for that year positive?

 
This simple test helps us determine whether or not the January Barometer is a good measure for the next 11 months.  As you’ll notice below in Figure 2, from 1999-2015, the S&P 500 Index was negative 9 times in January, but only ended the year negative 3 times (33% of the time), which means the other 6 times it ended the year in positive territory.  On the other side of it, the S&P 500 Index was positive 8 times in January, and ended the year positive 7 of those times (88%).  From 1926-2015 the data tells the exact same story. 
 
The point is - don't swayed by an interesting story with misleading statistics; there is usually more to the story than meets the eye. 

Figure 2: The January Barometer Test


So looking at the longer period from 1926-2015, an accurate conclusion would be that if January is up then there is an 85% chance the markets will finish the year positive and if January is down then there is only a 50/50 shot of the market being down for the year.  However, what has CNBC reported using the exact numbers above?  They have combined the rows for January Neg/Pos (34+55 = 89 Januaries) and combined the rows for years Neg/Pos (16+47 = 63) and claimed that yearly returns follow January returns 71% of the time!  How misleading is that!??  CNBC has combined a very reliable predictor (positive Januaries) with a unreliable predictor (negative Januaries).  It's somewhat analogous to claiming that Michael Jordan and I combined to score 32,292 points in the NBA.  It's true.  We combined for that many points - Michael all of them and me none of them.  That's exactly what CNBC is doing with the January Barometer nonsense.

Nobody knows whether 2016 will be positive or negative.  It's certainly started off on the wrong foot, but there are 11 months left for the markets to reverse course.  The key is to maintain discipline.  The regrets I hear from investors more often than not are about their failed attempts to time the market - getting out when they thought markets would go down or getting in when they thought markets would go up.  The key to investment success long-term is to stay invested through both up and down markets and if you were to buy or sell, all evidence shows that without a crystal ball one should heed Warren Buffet's wisdom to, and I paraphrase, buy when others are scared and sell when others are not scared. 

Volatility in equity markets is normal but right now it's scaring everybody which leads me to believe that those investors who are buying from panicked sellers are going to make off like bandits.  That doesn't mean stocks won't go lower from here.  The bottom of this current sell-off is anybody's guess.  But what it does mean is that corrections are almost always a time to either buy or sit tight....not a time for selling.  And when you hear that "everyone is selling" remind yourself that there is a buyer for every seller...so who is buying?!  Probably the Warren Buffets of the world, right?

Lastly, look back at Figure 1 above and remind yourself that long-term disciplined investors have been well rewarded for riding out the occasional down periods.  75% of years have been up and only 25% down. I like those odds.

Hang in there and take comfort in evidence and facts as opposed to the media's "creative reporting." And of course if you need further reassurance, our clients are welcome to call us anytime to discuss if and how these volatile markets are effecting their retirement dreams and goals.

Thanks for reading!

Lex Grecu, CFA, CFP(r)