posted on February 5th 2016 in Market Commentary & WorthPointe News with 0 Comments /

“As January goes, so goes the year.” At least that is the case according to the old adage made popular by the Stock Trader’s Almanac.  This phenomenon is also known as the “January Barometer.”  It simply means that January’s market’s performance, as measured by the S&P 500 Index, is a harbinger of how the market will do for the year.

January 2013’s rip-roaring start foreshadowed a very strong year. Nailed it.

The year 2009 also started with a thud in January. And the month we just ended has turned in the worst January performance since that year. But let’s note that while stocks bottomed in March 2009, they went on to post a strong gain.

Table 1: Key Index Returns

MTD % 2015 % 3-year* %
Dow Jones Industrial Average -5.50 -5.50 +5.67
NASDAQ Composite -7.86 -7.86 +13.52
S&P 500 Index -5.07 -5.07 +8.77
Russell 2000 Index -8.85 -8.85 +4.50
MSCI World ex-USA** -6.94 -6.94 -2.67
MSCI Emerging Markets** -6.52 -6.52 -11.44

Source: Wall Street Journal, MSCI.comMTD returns – December 31, 2015–January 29, 2016  Annual Returns – December 31, 2015–January 29, 2016   *Annualized  **USD

 

According to a recent story in the New York Times, the January barometer has been right 88% of the time since 1950 (ignoring basically flat years) and 75% of the time including all years. Over the last 35 years, the S&P 500 has followed January’s direction 71% of the time.

On the surface, it seems like a reasonable indicator. But it’s important to point out the data includes January’s performance.

In other words, how well or poorly month number one performs means you either have a head start or a handicap going into February. Still, January’s return has correctly foreshadowed February through December 66% of the time.

But the indicator does a much better job of predicting winners than losers, because markets are biased toward the upside.

For example, CNBC notes the S&P 500 Index has risen in 23 out of 35 Januarys since 1979. Over the next 11 months, the market subsequently rose in 19 of those 23 years—meaning a positive January has successfully predicted a winning February through December 83% of the time.

But in the years when January lost ground, there was only a 33% success rate in predicting a losing year.

That seems to have been an issue lately with the January barometer. Over the last 10 years, 2005, 2009, 2010, and 2014 began on the wrong footing but finished in the green, and we didn’t see a positive follow-through on 2011’s upbeat start.

“If you have a truly random variable, and there are, say, 60 million possibilities, it’s impossible not to find some pattern somewhere,” said Nassim Nicholas Taleb, a professor of risk engineering at New York University (New York Times).

You can always find interesting but useless correlations because stocks rise over the long term.

Wacky market indicators include the Super Bowl winner, butter production in Bangladesh, and whether an American model lands on the cover of the Sports Illustrated swimsuit issue. Geez, now we’re entering the theater of the absurd!

There are plenty of reasons why markets go up or markets go down. So we don’t believe that January necessarily sets the tone for the year.

Over the longer term, it’s about corporate profits, which are heavily influenced by the economy. In the shorter term, markets key off all kinds of variables. Long story short–what’s happening in the fall may make January look like a distant memory.

 

January’s poor start

There is no shortage of reasons why the year began on a sour note.

For starters, economic growth moderated at the end of the year.

Gross domestic product (GDP), the largest measure of economic activity, slowed from an annual rate of 2.0% in the third quarter to 0.7% in Q4, per preliminary data from the U.S. Bureau of Economic Analysis.

In turn, that has forced analysts to cut back on their forecasts for S&P 500 profit growth.

Last November, analysts were forecasting a rise in Q1 profits of 3.6%. As January came to a close, the increase had evaporated and analysts now foresee a drop of 2.7%. If we lose ground in Q1, that would make it the third straight quarterly decline. Put another way, it’s a profit recession that adds to short-term uncertainty in the market.

Yet, a sizable chunk of the weakness has to do with the near collapse in profits in the energy sector, which factors into overall corporate profits.

For consumers, it has been a windfall at the gas pump. But the beleaguered energy sector has been a net negative for the economy, creating steep cutbacks in oil and gas projects, which have in turn roiled manufacturing.

Moreover, the strong dollar continues to create headwinds for sales at U.S. firms that do a big chunk of business overseas. While a strong dollar is a gift for Americans vacationing in a foreign land, it works against revenues of homegrown firms because sales in local currencies must be translated back into a stronger dollar.

Then there are worries about China, oil prices, recession fears, woes in manufacturing, rising yields in junk bonds (mostly but not limited to energy and the mining sectors), the Federal Reserve, political uncertainty, and even stock sales by sovereign wealth funds.

 

What we sense when the market corrects

Many of us are painfully aware of the financial crisis of 2008.

Stocks have completely rebounded from the bear market and forged new highs. Someone who invested in the S&P 500 Index at the top in October 2007 would have earned a modest 4.9% on an annualized basis, including reinvested dividends, through the end of January.

While the wounds have healed, the scars remain, and some investors have a propensity to keep both eyes on the rearview mirror.

We get it. It’s human nature. It’s why we consistently advocate a disciplined investing approach –one that takes emotions out of the equation.

Let us share a story an economics professor told his class. It’s the story of two retailers –Sears and Montgomery Ward.

The Great Depression left a lasting mark on those who experienced its economic devastation. While the economy took much of the 1930’s to climb out of a deep hole, it wasn’t until World War II that growth really soared.

Simply put, the need to divert an enormous amount of resources into the war effort was an economic bonanza. Before going any further, let us assure you we are not downplaying the incalculable toll in human lives the war cost. This is simply an economic illustration.

After World War II, Montgomery Ward feared a new depression as peace returned and our men and women who so valiantly fought against tyranny came home.

Montgomery Ward retrenched and didn’t open a new store until well into the 1950’s. Sears, however, continued to expand, believing a depression wasn’t on the horizon.

Montgomery Ward never caught up thanks to its Depression-era mentality.

We believe the story teaches us a lesson today.

Every time clouds gather, we fear another deluge because the last storm is so fresh in our memory. While no one can predict the future, I believe another financial crisis won’t occur for many years.

We will experience bumps in the road, and we will go through another bear market. But rainstorms are followed by rainbows. It’s a graphic reminder that nasty weather is only temporary.

 

Know your risk tolerance

We always stress the importance of being comfortable with your portfolio and the risk you are taking. Market volatility is a normal part of investing. While it can be managed, it can unsettle some investors. It’s why we subscribe to a time-tested philosophy of finding the right mix of assets for your situation and adhering to that mix.

If your goals or personal situation changes, we can revisit your target.

One factor we use: your tolerance for risk. When markets are rising, some investors miscalculate how much risk they can handle and opt for a bolder approach.

While a more aggressive portfolio will likely create better returns over the long term, it’s not for everyone. Such a portfolio will see higher highs, but it will also see lower lows.

A more conservative approach smooths out, but does not eliminate the volatility. It may not capture the same returns over the long term, but it will allow those who are risk averse to sleep better at night.

As we’ve counseled in the past, know thyself. Understand how much downside you can stomach.

Resist the temptation to make buying or selling decisions solely based on the current market environment. Last month, we detailed the drawbacks of emotion-based investing, which can significantly reduce your long-term return.

We probably haven’t seen the end to the volatility–both upside and downside.

Yes, the long-term approach requires discipline, but it has historically been the best path to reach one’s financial goals.

about the author: WorthPointe Wealth Management

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