After A Less-Than-Kind January, Are Stocks Doomed In 2016?

“As goes January, so goes the year.”

According to this common Wall Street adage, the stock market performance during the month of January is a good barometer of what is likely to happen the rest of the year.

In other words, if the S&P 500 index posts a gain in January, the odds favor a rising stock market for the year. On the other hand, if the index posts a loss, the odds favor a negative year.

So, according to this adage, 2016 may not be a good year for stock investors. After all, we just had one of the worst January performances in history.

You see, two words have dominated the markets so far in 2016: China and oil. Chinese stocks started the year in free fall, with the Shanghai composite index closing January down about 20%. The sharp drop in Chinese stocks increased the fears that the economic slowdown in China would soon spread to other areas of the global economy.

And Chinese stocks were not the only asset that collapsed in January. The price of oil also collapsed and, at one point, was down 23%. Such a sharp drop increased fears that the low price of oil would lead to junk bond defaults in the energy industry and job losses in the oil patch.

As a result, January got off on a terrible note, and the Dow Jones Industrial Average had its worst 10-day start to a year on record going back all the way to 1897. At one point, the panic took over and the S&P’s loss for 2016 reached 11%. Just to give you an idea of how bad market sentiment got, economists at the Royal Bank of Scotland even sent a note to their clients warning that investors were facing a “cataclysmic year.” The note said the stock markets could fall by up to 20% and oil could slump to $16 a barrel. And, they advised their clients to “sell everything except high quality bonds.”1

Thanks to a recent rally, things didn’t turn out so bad. At least, not yet. Stocks recovered some ground late in January, and the index ended up closing the month down “only” 5%. Still, this was the worst January since 2009, which means that, according to the January barometer, 2016 may be a bad year for stocks.

But, should we trust the January barometer? In this article, we’ll examine if investors should really worry about last month’s performance.

Are We Really Doomed in 2016?
The barometer was devised by Stock Trader’s Almanac founder Yale Hirsch in 1972. According to Jeffrey A. Hirsch, Yale Hirsch’s son and the current editor of the Stock Trader’s Almanac, “the January barometer has registered eight major errors since 1950 for an 87.7% accuracy ratio.”2 In other words, this barometer has a pretty good track record, so it’s hard to dismiss it.

Besides, Mr. Hirsh points out the January barometer is just one of three red flags he has identified this year. The fact we didn’t have a so-called “Santa Claus Rally” in the last five trading days of December and the first two trading days of January is another red flag. The third red flag is the first five days measure of the market. This year, we had the worst five days on record, with the S&P 500 tumbling 6% over that period.

According to the Stock Trader’s Almanac, this trifecta of negativity has happened seven other times since 1950. Whenever it has occurred, the S&P 500 index closed the year down 5.5% on average.3

Now, before you sell your entire portfolio of stocks, you should keep in mind the January barometer isn’t perfect. One of the major errors occurred in 2009, for example. In January of that year, the S&P 500 lost 8.6%,4 marking the worst decline on record for the month. According to the barometer, 2009 should have been a terrible year for stocks. But, that’s not what happened. Despite the sour market sentiment at the time, investors started bargain shopping and the stock market began a violent rally in March 2009. By the end of the year, the S&P 500 had climbed over 23%.

So, the fact we just had a terrible January doesn’t mean we’re all doomed. At the same time, we shouldn’t dismiss the January barometer. After all, it has a respectable track record. It’s definitely a red flag. One way to prepare is to have a well-diversified portfolio and good risk management in place – just in case the January barometer turns out to be right again.

Until the next Daily Pfennig® edition…

Sincerely,

Mike Meyer
Vice President
EverBank World Markets, a division of EverBank
1.855.813.8484
everbank.com