On the close of January 29, the official January Barometer reading for 2010 was ready. In the days leading up to the close of the month there were numerous articles circulating throughout media outlets of all kind. With market sentiment at multi-year highs, frothy levels in fact; the vast majority of authors were already busy dismissing this year’s negative reading, even before it had been taken.
A common error throughout many of these articles was a lack of the basic fundamental reasons why the January Barometer exists, who is responsible for its creation and how to interpret it. Not a single article that I read explained why January is chosen, there are eleven other months in a year after all. So why is January the most important? Whose idea was it?
Yale Hirsch & 1933 “Lame Duck” Amendment
There would be no January Barometer without Yale Hirsch, founder of Stock Trader’s Almanac, as he is responsible for its discovery in 1972. It has been published in every annual edition since then. There would also be no January Barometer without the passage in 1933 of the Twentieth “Lame Duck” Amendment to the Constitution. Since then it has essentially been “As January goes, so goes the year.”
Prior to 1934, newly elected Senators and Representatives did not take office until December of the following year, 13 months later (except when new Presidents were inaugurated). Defeated Congressmen stayed in Congress for all of the following session. They were known as “lame ducks.”
Since 1934, Congress convenes in the first week of January and includes those members newly elected the previous November. Inauguration Day was also moved up from March 4 to January 20. As a result several events have been squeezed into January, which affect our economy and our stock market and quite possibly those of many nations of the world.
The basis for January's predictive capacity comes from the fact that so many important events occur in the month: new Congresses convene; the President gives the State of the Union message, presents the annual budget and sets national goals and priorities. Switch these events to any other month and chances are the January Barometer would become a memory.
Any back-testing of the January Barometer that includes data from before the passage of the Twentieth Amendment is not testing the January Barometer; it is only testing the first month of the calendar. When this approach is taken, the results are only slightly better than a coin toss and only serve to reinforce just how important the “Lame Duck” Amendment was. Since 1950 there have been only six major errors for a 90.5% accuracy ratio. Try finding another indicator with a history of this duration that has a better accuracy ratio.
Using the January Barometer
It is also a misconception to believe that the January Barometer was intended to be a buy/don’t buy trigger for the entire year. This approach has also been frequently cited during back-testing. If only investing were that simple, everyone would be wealthy and retired.
The January Barometer is best applied as a check against your current trading bias. If you are firmly in the bullish camp and a negative reading is given it may be time to reconsider your positions and vice-a-versa is also true. Trader’s can gain an even greater edge by combining the January Barometer with other yearend and January indicators.
Dow December Low is Crossed & January Barometer Negative
Of the 31 times since 1950 where the Dow closed below its December Closing low in the subsequent Q1 it declined further 29 times or 93.5% of the time. Both years, 1996 and 2006, that the Dow did not fall further the January Barometer was positive.
The 29 subsequent drops averaged 11.8% (not including 1996 and 2006). Average time frame is 152 days with a minimum of 2 days in 1991 (Schwarzkopf and Powell Beat Saddam) and a max of 345 days in 1969 (Summer of Love, Woodstock, followed by Vietnam escalation and Kent State in 1970 with bear market continuing to May 1970). 2008 was the worst drop – 42.1% over 323 days. Four occurred in less than 14 days and 13 in less than 90 days. 23 crosses occurred in January, 3 in February, 5 in March.
When both the December Low is breached and the January Barometer is negative only 1956 was spared a further decline as Ike's heart condition improved, though the market was flat for the year. In these years the S&P 500 hit the low for the year on average about six months later for an average drop of -14.2%.
Chart of Negative January Barometers & Dow December Low Crossings since 1938.
Interestingly, when both these indicators were negative, but the preceding Santa Claus Rally and First Five Days were positive, the average decline was a bit deeper at -16.2%.
Chart of Negative January Barometers & Dow December Low Crossings with positve Santa Claus Rally & First Five Days since 1938.
