By Mark Hulbert, MarketWatch
CHAPEL HILL, N.C. (MarketWatch) — The widely followed January Indicator will almost certainly turn bearish at the end of this month.
The indicator, which sometimes goes by the name of the January Barometer, was devised by Yale Hirsch in 1972, according to the Stock Traders Almanac. It holds that the stock market’s direction in January foretells its direction for the rest of the year.
I am jumping the gun in declaring that this indicator will be turning bearish on Jan. 31. But with only a handful of trading sessions left in the month and the broad market already down 8%, it seems highly unlikely that the indicator will be bullish at the month’s end.
On the surface, at least, the indicator rests on a solid foundation. Since 1896, when the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA -0.66% was created, there has been a 75% probability that the market’s February-through-December direction would be up if January recorded a gain. That contrasts with only a 52% probability following a losing January. (See the chart at the top of this column.)
This difference is significant at the 95% confidence level that statisticians often use when assessing whether a pattern is genuine.
However, this does not necessarily mean you should go to cash until 2017.
Notice from the above chart, for example, that even when January is a down month for stocks, there is still a better-than-even chance that the market will rise for the remainder of the year. So it would be incorrect to conclude that a bearish January Indicator means that the most likely outcome is a declining market from February through December.
Still, memories of 2008 are a big part of the January Indicator’s reputation: In January of that year, the Dow fell by 4.6%, and over the remainder of that year dropped an additional 30.6%.
However, the indicator is no better at foretelling big market drops than it is in other years. Consider the 20 years since 1896 in which the Dow fell by at least 10% from February through December: The Dow rose in 11 of those years’ Januarys, or more than half the time.
This relates to another curious feature of the January Indicator’s track record: The magnitude of the market’s performance appears to have no correlation with the market’s return over the subsequent 11 months. Oddly, that means that a big decline in January is no more bearish a signal than a tiny loss. (See table below.)
|When January’s return is ...||Average February-through-December return|
|Less than minus 5%||3.3%|
|Between minus 5% and 0%||4.2%|
|Between 0% and plus 5%||9.3%|
|Between plus 5% and plus 10%||7.6%|
|Greater than 10%||4.7%|
This discussion doesn’t mean that the market doesn’t face stiff headwinds this year. It undeniably does. But, as far as I can see, those headwinds aren’t made any stronger by the market’s awful performance so far this month.