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Stocks soared in January. Does that mean it'll be a great year?
According to an old adage on Wall Street, "as goes January, so goes the year".
Last month, we cast aspersions on the "January effect" as a predictive tool. And then the month turned out to be the best January for stocks since the 1990s.
Financial commentator Greg Heberlein and KPLU's Dave Meyer take a second look at January on this week's Money Matters.
The Dow Jones industrial average rose 5.8% last month, while the S&P 500 gained 5.1%. It was the best January for the Dow since 1994, and the best January for the S&P since 1997.
To many investors, that means stocks the rest of the year will rise.
How well does this January Barometer work?
As a measure of down Januarys to down years, it predicts the right direction only about half the time. So you might as well flip a coin. This is the main reason we previously dismissed it as a serious predictive tool.
But, the evidence is a little more compelling for Januarys in which the stock market goes up.
Since 1938, when the Dow Jones industrial average rose in January, the market rose three-quarters of the time (77%). On the face of it, that's impressive.
But what if you wait to see if the January market goes up, then invest? Again, it's impressive. In the rest of the year after an up January, the market rises 70 percent of the time (70.3%).
Looks like a slam dunk. This year, January was the best January since Bill Clinton was in the White House.
The statistics clearly state the odds are in the investor’s favor.
Hold on a minute! Compare the January Barometer to just any year for stocks.
Seventy percent of the time (68.9% since 1938), the stock market has risen.
So following the January Barometer gives you an ever-so-modest edge.
But if you wait until January is over, the chance of an up year for the remaining 11 months is virtually even with what every year’s outcome is.
Aside from the January effect, there are good fundamental reasons to support an up year. Employment and the overall economy are on the rise. Corporate profits continue to march higher. The government seems to be making inroads on the nation’s historically high debt. The European financial crisis has calmed down considerably.
But face it, who buys stocks for a precise 11-month or 12-month period?
If it's your intent to gamble on short-term market swings, why wait for a whole year to elapse?
Pick the market’s best three-month stretch – November, December and January. On average, those three months generate a gain of more than 4 percent. That’s about half of a year’s normal return.
Or try this. If roughly three-quarter’s of the time the market goes up, don’t try to miss the bad periods. Stick to the buy-and-hold policy and count on excellent returns over time.