Is the Stock Market Doomed by This Awful January?

In sharp contrast to the New Year’s Eve celebration in Times Square just days ago, the mood on Wall Street is decidedly apprehensive.

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Global stock markets tumbled in the first day of trading for 2016, catalyzed primarily by economic growth concerns in China. Weak manufacturing data for the Asian powerhouse sent a ripple effect against stock prices; the Shanghai Composite Index dropped nearly 7% before trading was forcibly halted by securities officials.

Fresh conflicts in the ever-volatile Middle East — this time sparked by Iran’s outrage over Saudi Arabia’s execution of a popular Shiite imam —  caused violent swings in the price of crude oil. Investors stateside absorbed the implications of the news, ultimately dropping the benchmark S&P 500 by more than a percent on Jan. 4.

When the stock market failed to recover the following day, many raised concerns of a weak start becoming a harbinger for the rest of the year. Wednesday and Thursday’s trading only reinforced those suspicions.

But does a bum note in January really increase the likelihood of negative annual returns?

This is an area where perception can often overpower the facts. From 1962 to 2015, the S&P 500 has actually had more instances where the first day of trading fell into red ink — 29 down days versus 25 up days. However, by the end of the year, the circumstances significantly favor the bulls, with poor January starts resulting in just eight negative returns in those years.

Put another way, a bad January opener predicts a bad year less than 28% of the time.

With statistics like that, investors might be better served buying the fear in stock prices rather than selling it.

This too, though, is a bit of an oversimplification.

Based on tax benefits and other financial considerations, there are significant advantages in dumping equities in the final days of December. Once January rolls around, stock market participants are typically testing the waters — after all, there’s no point in going guns blazing when the whole year is ahead of you. And because the stock market has a long-term upward bias — S&P 500 annual returns average 7.6% since 1962 — there is a natural tendency for so-called January harbingers to fail.

Stock market INX chart
Source: Source: JYE Financial, unless otherwise indicated

This is true whether you look at the dynamics of stock prices on the first day, the first week or the entire month of January. In the past 54 years, there have been 24 times in which the first week of the year fell into the red, whereas the first month has sunk 22 times.

Either way, these barometers are essentially useless. A negative first week predicts a down year only 50% of the time, and a below-par month is only slightly better at a 55% accuracy rate.

Mathematically speaking, it’s a coin toss.

What happens, though, when a series of bearish events — namely, a combination of selloffs in the first day, week and month of the new year — converge to attack the stock market?

In such an extraordinary case, the predictability of future disaster percentage-wise is quite high. Consider that of the eight times this “bear sweep” has occurred, it has predicted a downturn five times, or 63%. This includes some of the worst years in modern stock market history — most notably the 2008 collapse in global stock prices.

But even this version of the January barometer is not without its caveats. Because the number of bear sweeps is infrequent, any one event can seriously distort the overall picture. For example, last January’s numbers hit red on all three counts, and correctly predicted a loss for the year — but barely. The stock market was literally a few points shy of rendering the bear sweep as yet another useless platitude, and it took a slide in the final days of the year to accomplish it.

Rather than focusing exclusively on bare numbers, investors should instead study the broader context of the markets — because the numbers could just be a false correlation.

Namely, no matter what January does, every year has 11 more months in which to do just about anything. If January is weak, any event that damages sentiment in the stock market later in the year has the appearance of a cause-effect relationship. The 2008 collapse, for instance, was coming one way or another — a mild or even strong January wasn’t going to change that outcome.

Or consider the stock market crash of 1973-74. Stock prices tumbled around 17% in 1973 thanks to global monetary unrest, a sinking dollar and an oil outbreak. Forget the weak January — a downturn for stock prices was virtually an inevitability regardless.

Don’t Sweat the Stock Market Because of January

In short, reading into any of January’s trades is a woefully unreliable indicator of long-term stock market performance. Seasonality trends, along with a litany of outside variables, create an aura of a statistical relationship that just isn’t there.

While poor performance in stock prices should not be ignored — especially when it comes to seasonality — investors must primarily recognize the greater context to gain a more complete understanding.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

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