Trader’s Narrative

Groundhog Day is only a few days away! According to lore, if the groundhog sees its shadow, we’re going to have another 6 months of winter. If on the other hand, it fails to see its shadow, winter will end soon.

The January barometer can be likened to ground hog day but it has more historical evidence. The January barometer basically says that the performance in the first month of the year, predicts the market’s return for the rest of the year.

The S&P 500 Index (SPX) started January at 902.99 and ended the month at 825.88 for a return of -8.5%. The Dow fared worse with an 8.8% drop. For both indices it the worst January return on record.

So the groundhog has definitely seen its shadow and the bear market will continue.

The only faint silver lining is that the historical basis for a negative prediction is very flimsy. Probably due to the upward bias of the stock market over the very long term, the prediction quality of the January barometer is higher in bull markets. So this prediction of a continued bear market has only about a 40% chance of being accurate.

UPDATE:
Here’s an interesting related article by Nick Godt at MarketWatch

The beginning of the year is a special time that rightly attracts much attention. The January effect is mostly over by now and hopefully you were able to trade this phenomena profitably. It is too bad it only comes around once a year.

There are a few other similar patterns for January. Probably the best known is “as January goes, so goes the year”. Another says that the first 5 trading days determine the market’s returns for the whole year ahead. And another says that how January performs predicts the direction of the market for the remaining months of the year.

Mark Hulbert showed a few days ago in this column that the 5 first trading day pattern simply isn’t true. In fact, the only one that does have validity historically is the third one listed above. The January Barometer says that the performance for the first month has a predictive quality for the returns generated between the second and twelfth months.

Because of the positive bias of the market, this indicator works best when it predicts a bullish scenario for the remaining 11 months of the year. From 1940 to 2008, January’s return was positive 43 separate times. Of these, 86% of the time the next 11 months were also positive. On the other hand, in only 40% of the cases when January was negative was the rest of the year also negative. The overall accuracy of the January Barometer within that time range was 73.9%.

So with an almost 75% historical accuracy rate, we’ll have to wait until the end of this month to see what it augurs for the rest of the year.

Below is a look at the raw data from 1940 to 2008:
Continue reading ‘The January Baromoter’