The Bigger the January, the Better the Year

by James Brumley | February 2, 2012 8:58 am

If you’re a fan of the January Effect[1] — the assumption that how January goes, so goes the year — then you’re undoubtedly excited by that fact that January 2012 wasn’t just positive, it was the most bullish January we’ve seen since 1999. The S&P 500 gained a whopping 4.3% last month, versus the average January advance of 1%.

Not bad.

If you’re not a fan of the January Effect and consider it just another way for the financial industry to keep you interested … well, you might want to rethink your whole “this is hogwash” stance. As it turns out, there’s actually something to it.

More than that, though, the unusual size of this January’s gain means something special in and of itself.

Color Me Surprised

In the interest of full disclosure, I’m generally not a fan of market theories that strictly follow a calendar and completely ignore underlying results. On the other hand, my loyal adherence to an almost-scientific approach to investing forces me to acknowledge one thing: The January Effect theory has the statistics to support its premise.

That’s right — it works. I won’t review the track record here again, since I already did it Dec. 28[2].

In the meantime, though, I uncovered something else I wasn’t expecting to find.

We’ve already verified that a positive January means stocks have an 80% chance of posting positive results for that full year. But did you also know that the stronger the January numbers, the greater the odds are (above and beyond that 80%) of a positive return for the whole year? Likewise, the stronger the January return, the stronger the results for that year are likely to be.

Numbers tell the tale. Going back to 1950, the S&P 500 posted returns of 4% or more 19 times. In 18 of those instances, the market made big gains for the year (the oddball was, not surprisingly, 1987). In fact, the average market gain for those “Big January” years was a hefty 15.2%. When the January gain still was positive but less than 4%, the average gain for that year was a tepid 8.7%.

That’s a statistically significant difference, and following this year’s 4.3% January rally, it’s something to feel good about.

Will 2012 Follow Suit? Not Necessarily Right Away

Of course, history is one thing — the present is another. Will this year be an exception to the norm, or are we going to see stocks post solid results thanks to January’s bullish romp?

I’ve made no secret of my bullish stance. I’m a believer in the recent “Golden Cross”[3] buy signal, and I made the point back on Jan. 19 that stocks are greatly undervalued right now[4]. I feel stocks are positioned to go at least moderately higher in 2012, and that expectation hasn’t changed. In fact, it was just bolstered by this year’s red-hot January.

There’s a caveat to that call. though. This is a point I made before, but it bears repeating now: Stocks don’t move in a straight line for very long.

I don’t know if 2012 will be a bullish year because January was bullish, or if 2012 will just be a bullish year in addition to January being bullish. I do know, however, there will be several points in time during 2012 when we all have serious doubts about this year being a gainful one.

The market ebbs and flows. That’s just the way it is. The end of the year is 11 months away, and a bunch of good and bad things can happen in the meantime.

I reiterate that message mainly because I fear we’re all looking back on a great January and expecting perfect bullishness between now and Dec. 31. Sorry, but it’s just not likely to play out that way. I’m almost positive the market’s going to be lower than where it is now at some point between now and then.

That’s OK, though. This is a long-term theory, and you can tweak your entries in the meantime. Just don’t ignore it.

Endnotes:
  1. January Effect: http://investorplace.com/2011/12/january-effect-stock-market-fact-or-fiction/
  2. already did it Dec. 28: http://investorplace.com/2011/12/january-effect-stock-market-fact-or-fiction/
  3. “Golden Cross”: http://investorplace.com/2012/01/golden-cross-sp-500-buy-signal-technical-analysis/
  4. stocks are greatly undervalued right now: http://investorplace.com/2012/01/3-undervalued-stocks-to-buy/

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