January Barometer

Posted on 26 January 2016 by Almanacist

The January Barometer holds that the direction of the market in January predicts the direction of the market for the whole year. The saying is:

“as January goes, so goes the year”

The January barometer was first mentioned by Yale Hirsch of the Stock Trader’s Almanac in 1972.

NB. The January Barometer is sometimes confused with the January Effect (more on this confusion here).

So, does the January Barometer work?

According to John Dorfman in an article in January 2016

the barometer has been correct in 38 of the past 54 years for a success rate of 70 percent.

70% accuracy is not bad. Although Dorfman does point out that this under-performs a naive model (which forecasts the market will be up every year) which has an accuracy of 74% over the same period.

How does the January Barometer fair in the UK market?

Let’s jump straight in with a long-term view. The following chart plots the January and same-year full-year returns for the FTSE All-Share Index since 1800.

To support the January Barometer there needs to be a majority of points in the top-right and bottom-left sectors (i.e. both positive returns for January and the full year, or both negative for January and the full year). And, yes, broadly that does seem to be the case. The line of best fit has a positive slope which agrees with our visual inspection. The correlation (R2) is very low, but to be fair the January Barometer does not claim there is a close correlation in (January and full-year) returns, just that the sign (i.e. the direction) is the same.

We’ll now look at a shorter period to see how the relationship changes over time.

The following chart is as above except the time period is from 1900 to the present day.

Since 1900 the relationship has remained largely the same, i.e. the January Barometer broadly holds.

Finally, we look at the (relatively) short-term; the chart below shows the relationship since 1980.

And, again, the January Barometer still seems to have worked since 1980.

The following table summarises the success rate of the January Barometer over the three time periods. For example, since 1800, the Barometer has been correct for 61% of years.

The table also includes figures for the success rate for years in which the returns in January were respectively positive and negative. For example, since 1800 the Barometer was correct for 65% of years in which the market rose in January.

	Jan (all)	Jan (up)	Jan (down)
1800-2015	61%	65%	55%
1900-2015	66%	69%	60%
1980-2015	72%	87%	46%

As can be seen, for all three periods the Barometer had success rates of over 50% for all years – and so can be considered to have worked. Since 1980 the Barometer has been notably successful.

But there can be seen a difference in accuracy between years in which January returns were positive or negative. The Barometer works better in years with positive returns.

The January Barometer since 1980

The following chart might help to visualise the behaviour of the Barometer in recent years. The chart plots the performance of the Barometer for each year from 1980; a 1 is plotted for years in which the Barometer worked, and a -1 in those years when it didn’t.

Of late the performance has been patchy, but there was a remarkable run of 12 years from 1982 in which the Barometer worked every year. It should be noted perhaps that the market was strong in this period: annual returns were positive for every year except one year. And, as we saw above, the Barometer does seem to work better in years when the market rises.

Economic significance

So, is the January Barometer economically significant – i.e. can you trade it profitably?

The following chart plots the FTSE All-Share returns for January and the full-year for the period 1980-2015.

A concern might be that a significant portion of the full-year returns might be accounted for by the month of January itself. In other words, by the time one acts on a signal from the Barometer, the market has already moved significantly. However, the chart shows that although a disproportionate size of the full year return have been accounted for in January, the remaining returns are significant.

Over this 1980-2015 period, if a strategy had invested in the market from February to year-end just in the years that the Barometer gave a signal for a positive market, the average annual return in those years would have been 9.5%. This is marginally better than the average market return for all years over the same period of 9.0%.

Conclusion

The January Barometer has had a better than 50% success rate for the three periods studied here: 1800, 1900, and 1980 to the present day.

Although one should be wary about assigning a special relationship between January and the full-year. For example, since 1800 the month of February has been almost as good as January in predicting full year returns, and since 1900 February has had a higher succes rate in positive return years.

Do the first five days predict the full year?

Posted on 10 January 2016 by Almanacist

The January Effect refers to the tendency of small cap stocks to out-perform large-cap stocks in the month of January. However, the term January Effect is used rather loosely to also refer to stocks generally being strong in the first month of the year, and also to how the direction of the market in January forecasts the market direction of the whole year (this latter effect is also termed the January Barometer). [A previous article explained the multiple January Effects in greater detail.]

Here, we are going to look at a variant of the January Barometer to see if the first five days of the year predict the return for the whole year.

First, we will call this variant of the January Barometer: January Barometer (5D).

The bald figures don’t look encouraging: in the 46 years since 1970, the January Barometer (5D) applied to the FTSE All-Share Index has been right in 26 years (57%). In other words in just over half the years since 1970 the first five days of the year have accurately forecast the full year.

But let’s look at this in more detail and see if we can tease anything out of the figures

The following is a scatter chart that plots the return on the FTSE All-Share Index for the first five days of a year against the return for the full year, for the period 1970-2015.

There is a positive correlation here (given by the positive sloping trend line), however the measure of correlation (R2) is very low.

Summary: the chart shows there is a very low level of correlation between first five-day returns and returns for the full year but it is far from being significant.

However, strictly, the January Barometer only says the direction (i.e. positive or negative returns) can be forecast, not the size of returns. In which case the following chart may be more useful. This plots a binary value for each year:

1: if the sign on the full year return was the same as the sign for the return for the first five-days (i.e. either both positive returns or negative returns)
-1: if the sign on the full year return was different to the sign for the return for the first five-days

In this chart we can see the roughly even split between years when the January Barometer (5D) works and those years when it doesn’t. However, the distribution of years when it works is interesting, as there does appear to be a certain clustering of years when the effect works and when it doesn’t.

For example, in the last 20 years the January Barometer (5D) has been accurate 14 times (a hit rate of 70%). And since 2004 there is this rather odd pattern of not working every fourth year.

US presidential elections

US presidential elections also have a four-year cycle. On the chart presidential years are marked with orange bars.

It can be seen that since 2004 the January Barometer (5D) has worked every year except in years before presidential elections.

And, over the longer term, since 1970 the January Barometer (5D) has only failed in three presidential elections (a success rate of 73%).

The outlook for 2016

Generally, the January Barometer (5D) has a low success rate. However, the effect has been more significant in recent years; plus it has a higher significance in US presidential election years (which 2016 is). In 2016 the market was down in the first five days of the year, and so the January Barometer (5D) would forecast a down year with a 73% probability.

The January Effect(s)

Posted on 10 January 2013 by Almanacist

It’s January, so let’s talk about the January Effect.

But which January Effect would that be?

We’ve come across three different uses of the term. A quick overview follows.

1. Small-caps out-perform large caps in January

The most common use of the term January Effect describes the tendency of small-cap stocks to out-perform large-cap stocks in January.

In 1976 an academic paper found that equally weighted indices of all the stocks on the NYSE had significantly higher returns in January than in the other 11 months during 1904-1974. This indicated that small capitalisation stocks out-performed larger stocks in January. Over the following years many further papers were written confirming this finding. In 2006 a paper tested this effect on data from 1802 and found the effect was consistent up to the present time.

The UK market experiences the same January Effect as seen in the US market. The small cap out-performance in January is significantly strong: the FTSE Small Cap Index has out-performed the FTSE 100 Index by an average 3.7 percentage points in all Januaries since year 2000. And the small cap index has under-performed the FTSE 100 Index in just one year in the past 13.

The following chart shows the average FTSE Small Cap Index out-performace of the FTSE 100 Index for each month since 2000.

2. January predicts the market for rest of the year

Historically, the returns in January have signaled the returns for the rest of the year. If January market returns are positive, then returns for the whole year have tended to be positive (and vice versa).

This is sometimes called the other January effect, or January Predictor or January Barometer and was first mentioned by Yale Hirsch of the Stock Traders Almanac in 1972. A variant of this effect has it that returns for the whole year can be predicted by the direction of the market in just the first five days of the year.

Academic research has largely found that January returns can predict the rest of the year, but there is some doubt as to whether the effect can be exploited.

And Dan Greenhaus of BTIG points out that January is not necessarily any better a predictor of full year performance than any other month. According to him,

When February is down, the 12 month return inclusive of that February is 2.0%. When February is up, the S&P 500 returns 12.53%

and similar for the other months.

3. The market tends to rise in January

In 1942 Sidney B. Wachtel wrote a paper, “Certain Observations on Seasonal Movements in Stock Prices”, in which he proposed that stocks rose in January as investors began buying again after the year-end tax-induced sell-off.

Looking at the returns for the FTSE 100 Index since 1984, it is true that they tend to be positive – but not strongly so. The index has risen in 57% of all Januaries since 1984 with an average increase of 0.3% – which ranks it in eighth place of the 12 months.

References

Haug, Mark and Hirschey, Mark, The January Effect (2005)
Rozeff, Michael S. and Kinney, William R. , Capital market seasonality: The case of stock returns (1976)
Wachtel, Sidney B., Certain observations on seasonal movements in stock prices (1942)

Other papers:

Bohl, M. T. and C. A. Salm, The other January effect: international evidence (2009)
Bohl, Martin T. and Gottschalk, Katrin and Henke, Harald and Pál, Rozália, Institutional investors and stock market efficiency: The case of the January anomaly (2006)
Brown, Lawrence D. and Luo, Liyu, The January Barometer: Further Evidence (2006)
Brown, Lawrence D. and Luo, Liyu, The Predictive Value of the Signs of January Returns: Evidence of a New January Effect (2004)
Cooper, Michael J. and McConnell, John J. and Ovtchinnikov, Alexei V., What’s the Best Way to Trade Using the January Barometer? (2010)
Cooper, Michael J. and McConnell, John J. and Ovtchinnikov, Alexei V., The other January effect (2005)
Easterday, Kathryn E. and Sen, Pradyot K. and Stephan, Jens, The Persistence of the Small Firm/January Effect: Is it Consistent With Investors’ Learning and Arbitrage Efforts? (2008)
Easton, Stephen A. and Pinder, Sean. M., A refutation of the existence of the other January effect (2007)
Ghosh, S., G. Bhalla, and W. T. Ziemba, The January barometer, 1926-2005 (2007)
Guler, Sevinc, January effect in stock returns: evidence from emerging markets (2013)
Lit, Ho-man Vienna, The January effect revisited : evidence around the world (2007)
Marshall, Ben R. and Visaltanachoti, Nuttawat, How Accurate is the January Barometer? (2008)
Marshalla, Ben R. and Visaltanachoti, Nuttawat , The Other January Effect: Evidence against market efficiency? (2010)

The UK Stock Market Almanac

Seasonality analysis and studies of market anomalies to give you an edge in the year ahead

Tag Archives: January Barometer

Do the first five days predict the full year?

US presidential elections

The outlook for 2016

The January Effect(s)

References