Portfolio > Economy & Markets > Stocks

More Barometric Folly

Your article was successfully shared with the contacts you provided.
Index January 2004 QTD YTD Description
S&P 500 Index* 1.73% 1.73% 1.73% Large-cap stocks
DJIA* 0.33% 0.33% 0.33% Large-cap stocks
Nasdaq Comp.* 3.13% 3.13% 3.13% Large-cap tech stocks
Russell 1000 Growth 2.04% 2.04% 2.04% Large-cap growth stocks
Russell 1000 Value 1.76% 1.76% 1.76% Large-cap value stocks
Russell 2000 Growth 5.25% 5.25% 5.25% Small-cap growth stocks
Russell 2000 Value 3.46% 3.46% 3.46% Small-cap value stocks
MSCI EAFE 1.42% 1.42% 1.42% Europe, Australasia & Far East Index
Lehman Aggregate 0.80% 0.80% 0.80% U.S. Government Bonds
Lehman High Yield 1.91% 1.91% 1.91% High-yield corporate bonds
Carr CTA Index -0.46% -0.46% -0.46% Managed futures
3-month Treasury Bill . . 0.08%
Estimates as of January 31, 2004. *Return numbers do not include dividends.

With the first month of the year showing impressive returns for nearly every size and valuation segment of the market, the excitement of the fans of the so-called “January Barometer” can hardly be contained.

Simply put, the indicator is said to portend a good year for stock investors if the market boasts a positive return in January. But if stocks tank in the first month of the year, that’s a signal the market is heading lower.

To get a more detailed look at how valuable the January Barometer actually is, an examination of its more recent results is in order. Over the last quarter century, for example, the barometer has correctly predicted the direction of the market 19 out of 26 times, for a 73% success rate.

The ‘edge’ enjoyed by fans of the barometer is obvious to anyone with even an elementary background in statistics. The odds that the year as a whole will sport a gain if January is positive are higher than if January is lower. But if one tries to use the January Barometer to predict how the eleven months following January will fare, the track record is much different.

Let’s suppose, for example, that one predicts that every February-December period from 1975 to present will be profitable. That simple guess turns out to be 86.4% accurate, which makes the barometer look absolutely amateurish in comparison.

But the real Achilles’ heel of the January Barometer is its record of calling bear markets. Over the last one hundred years, predicted stock declines by the barometer have been accurate only about 52% of the time. In fact, the last incorrect prediction by this famed indicator occurred in 2003, when a negative January was followed by a 23% gain for the full year.

In my opinion, a far more important input in predicting the path of stock prices is the most likely direction of interest rates. The Fed’s proclamation last week that it was bracing for a period of less accommodative policy is, in my opinion, a watershed event for all investors. While my expectation on returns from the bond market has been significantly reduced, the impact on equities is far less certain. Considering our current significant economic growth, I still expect a positive return for the S&P 500 index in 2004. But the fact that my prediction agrees with the January Barometer is sheer coincidence.

More on this topic