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The January Barometer: Not Just an Anecdotal Indicator

January can often be a telling month for the stock market. In fact, the results from several studies have shown how January’s performance can be a harbinger of future stock market returns for the year ahead. One such study is referred to as the January Barometer. Specifically this stock market test assesses the direction of the Dow Jones Industrial Average (INDU) after the first five days, then the balance of January, in order to make a statement for the expected performance of the stock market during the remainder of the year. For example, Jay Kaeppel published his results of the January Barometer in Technical Analysis of Stocks & Commodities and found that the direction of the first five days of January, confirmed by a continuation of that pattern throughout the end of January, is often followed by the same pattern for the rest of the year. Also, if the market were to post a positive return for the first five days but reverse trend and end the month in the red, the expectations are for negative returns for the rest of the calendar year. Conversely, if the market closes lower for the first five days but then higher into month-end a higher close by year-end can be expected.

Additionally, Perry Kaufman conducted a more recent analysis of the January Barometer from 1989-2010 and experienced similar outcomes under a different time period. However, while Kaufman found a direct correlation between January’s performance and that of the rest of the calendar year the price change for the remainder of the year was nominal on average.

While January may provide some indication of future events for the stock market, price action should be constantly reassessed for signs that may be contrary to what January’s performance indicates. No one indicator is perfect but considering these statistically significant results and recurring price phenomena, the January Barometer can be a useful part of a trader’s analysis.

Implications for 2016:

Staying consistent with the previously mentioned studies, INDU offers the following information. The first five trading days of 2016 netted -6.19% and for the month of January it posted returns of +0.73%.  The entire month of January returned -5.50% for the Dow Jones Industrial Average. Applying the implications from above, INDU may have a chance of closing 2016 higher than 2015. However, when considering the general market environment at this point, this should be taken as a weak signal from the January Barometer for a higher year-end close. Additionally, Friday’s higher close can be attributed to the Bank of Japan’s surprise monetary easing announcement which helped to push up global asset prices on the last trading day of the month.

Contrary to the INDU’s performance, the Russell 2000 (RUT) paints a different picture for 2016. While equity markets have been trending down since late summer of 2015, RUT has been leading other indexes to the downside. Its returns for the first five trading days amounted to -8.96% while the remainder of January returned -1.03%. For the entire month of January RUT posted a -9.90% total return. Given the results of the January Barometer study, traders should expect for RUT’s close in 2016 to be lower than 2015. Of course, this price action may already be reflected in the market but only time will tell.

While the January Barometer has had some past success in predicting the closing value of a market relative to its previous year, all indicators should be taken with a grain of salt and thoroughly tested before applied in real trading. Both Kaeppel and Kaufman have analyzed extensive data sets and their results offer useful findings for application.

As always, please feel free to contact me with any questions.

JD
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