What is the January Barometer?

January 9, 2023

What is the January Barometer?

The January Barometer is a market hypothesis that suggests the stock market’s performance — specifically the S&P 500 Index — in January predicts the performance for the rest of the year. 

In other words, positive returns in January would indicate positive future results for the remainder of the calendar year.

Yale Hirsch first popularized this idea when he published The Stock Trader’s Almanac in 1972. While not as commonly believed today, there are many traders who still follow this theory. 

How Does the January Barometer Work? 

This hypothesis is based on the premise that the stock market is cyclical, and that performance in the first month of the year is a strong predictor of stock market performance for the full-year.

Investors who utilize the January barometer are traders who attempt to time financial markets. Timing the market means they invest when an indicator forecasts a bullish year, and stay out of the market when a bearish year is forecasted.

The January Barometer has two aspects: returns in the first five trading days of January and total January returns.

The Stock Trader’s Almanac calls the first five days as the “Early Warning System,” and has slightly lower accuracy than the full-month January performance.

Accuracy of the January Barometer 

Since tracking began in 1950, the indicator has been wrong only 10 times, meaning it has an 85.7% accuracy ratio.

This alone may not indicate any true effects because from 1945 to 2021, U.S. equity markets have generated position annual returns nearly 70% of the time. Those 10 errors were times the market ended higher after a negative January.

This means the January Barometer could just indicate the general trend of the U.S. stock market rising each year, as opposed to a specific indicator that can be used for investors to improve their market timing.

Because of this past trend of stocks rising annually, an up January is more accurate indicator than a down January. However, this may simply be caused by this directional bias.

Some critics of the January Barometer note that this phenomenon is not seen in any other global capital markets, only on Wall Street.

Examples of the January Barometer

The January Barometer has shown mixed results in recent years.

For example, in 2021 the S&P 500 fell 1.1% in January, but ended the year with a nearly 27% increase. In contrast, the S&P 500 increased by 7.87% in January 2019 and finished the year with a 28.9% gain.

In 2022, the S&P 500 lost 6% in January — the worst-performing first month of the year since 2020, when the COVID-19 pandemic was beginning to unfold globally.

In 2020, the Barometer failed because of the global impacts of the COVID-19 pandemic and the following stock market rally — dropping 0.16% in January and ending the year with 16% positive returns. 

What is Seasonality? 

Stock market seasonality refers to the tendency for certain securities or market indexes to exhibit predictable, recurring patterns of performance at certain times of the year.

For instance, holiday spending can significantly impact full-year revenue growth for retail companies.

Other examples of stock market seasonality include the “summer rally,” in which stock prices tend to rise in the summer months, and the “September effect,” in which stock prices tend to be lower in September compared to other months.

It is important to note that stock market seasonality is not a guarantee, and there can be significant variations from year to year.

What is the Santa Claus Rally?

The Santa Claus rally, also known as the “December effect,” is a phenomenon in which stock prices tend to rise in the last week of December and the first two trading days of January.

It is believed to be caused by positive sentiment around the holiday season and the beginning of a new year, as well as tax-loss selling and portfolio rebalancing by institutional investors.

However, it should be noted that the existence of the Santa Claus rally is disputed, and some studies have found that stock returns during this period are not significantly different from returns at other times of the year.

What is the January Effect?

The January effect is the perceived increase in stock market returns during the month of January. Some economists believe one possible reason for the January effect is that investors use year-end cash bonuses to make investments at the start of the year.

Another explanation is that it’s caused by an increase in buying after the end-of-year sell-offs investors use to offset realized capital gains.

However, the January Effect hasn’t been an accurate phenomenon in recent decades.

The Bottom Line

The January Barometer is a popular hypothesis that suggests the stock market’s performance in the month of January can predict its performance for the remainder of the year.

While some studies have found a positive correlation between January performance and full-year returns, others have found no significant relationship.

A variety of factors, including economic conditions, company fundamentals, interest rates, and market volatility, can influence stock performance throughout the year.

As with any investment strategy, it is crucial to do thorough research and consider your own investment objectives before making decisions.

The information in this article is presented for educational purposes only. Information should not be construed as investment advice or form the basis of an investment decision.

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