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It’s safe to say that investors were looking forward to turning the page on 2022. It seems like markets were ready too. As of the last few trading days of January, several equity and bond asset classes have notched their best January in history!
I know what you’re thinking: It’s just one month—what’s the big deal? It’s true that you should NEVER overreact to one month, good or bad. Still, some say January holds a little more weight than other months, especially following a down year.
The question is whether you should pay attention to this trend. That is what the rest of this commentary will address.
The Barometer
The January Barometer devised by Yale Hirsch states that as January goes, so goes the year. If the S&P 500 experiences a positive monthly return, it’s likely to end up for the year. But if it experiences a negative monthly return, it’s likely to end down for the year.
At first glance, the historical data looks compelling. Between 1950 and 2021, the barometer was accurate 84.5% of the time, with only 11 instances when it deviated from the trend. This may have you thinking, how can you NOT use this as an investment strategy?
Well, the reality is markets tend to rise more than they fall. Since 1926, the S&P 500 has experienced 74 positive years (~75%) to only 24 negative years (~25%). This tells me the barometer is likely just a byproduct of markets generally ending each year higher than the year before.
Source: Dimensional Funds.
This reduces the appeal of the barometer since markets are at or near all-time highs quite often! There have been instances where the barometer “worked” perfectly, but also several times when following it would have cost investors dearly. Let’s look at a few examples:
January 2009 = -8.5%. S&P finished the year +26%.
January 2010 = -3.8%. S&P finished the year +14.8%.
January 2018 = +5.2%. S&P finished the year -4.2%.
January 2021 = -1.1%. S&P finished the year +28%.
The data points above clearly indicate that this barometer should be taken with a grain of salt, not as a hard-and-fast rule. While a positive January likely has a psychological effect on investors, especially following a negative year, not much fundamentally changes from December to January. It is true that the fear of missing out (FOMO investing) can creep into investors’ minds when markets start the year positively, but there are far too many instances where the opposite has occurred.
Another thing to keep in mind is investor discipline. Even if the barometer was far more accurate, it demands that investors never panic or deviate from the various data points. As we have learned, many investors do not have that level of discipline, as volatility has a way of wreaking havoc on the best-laid plans.
Many pundits point out how the barometer seems to be “successful” with only the S&P 500 and not with other U.S. or foreign markets. I find it hard to believe that any barometer of this magnitude can accurately predict the annual returns of the S&P 500 but no other market. It has also been mentioned how other months are as good, if not better, predictors for market performance when in reality, none of them really holds much weight.
It is important to remember that markets are complex mechanisms operating on a multitude of factors. The performance in any single month is NEVER the sole reason why markets end higher or lower in any given year. Sticking to your financial plan and reassessing your risk tolerance along the way are the best things you can do.
What will this year bring? It remains to be seen …
Discuss your situation with a fee-only financial advisor.