The Truth Behind the “January Barometer”

January 10, 2023

There are dozens of memorable little “guidelines” about how the market performs during certain times of the year. Maybe you’ve heard of a few.

I’m talking about nuggets like:

“Sell in May and go away…”
“The June Swoon…”
“The October Effect…” (which has a cousin called “The September Effect”) 
“The Santa Claus Rally…”

These are all supposed to give you an edge in the market by showing you how the market tends to behave. Some people follow them religiously. Some ignore them entirely. 

There’s one in particular that turns up every time we flip the calendar to a new year — it’s called the “January Barometer.” 

Since we’re in the middle of the month, I thought we could take a closer look at it to see whether it’s worth following…

The Rules of the Game

The concept of the January Barometer was devised by market analyst Yale Hirsch way back in 1972. The publication he founded, the Stock Trader’s Almanac, was known for identifying seasonal patterns that occurred in the market.

The January Barometer was one of them.

The basic idea behind this nugget often gets boiled down as, “As goes January, so goes the year.” The real tendency is a lot less sexy. 

Hirsch’s hypothesis says that if the stock market closes higher in January, then 70% of the time it will close above January’s gains at the end of the year. Don’t get too excited. That means if the S&P 500 closes three index points higher in January, then closing four index points at the end of the year fits the pattern. Not really that impressive.

The flip side is even less helpful…

If the major indices close lower in January, “the potential for the rest of the year to be positive reverts to its normal 55%.” So a down January doesn’t mean a down year. Only a potentially less bullish year than with a higher close.

Again, IMHO, not a particularly big edge for investors.

Should You Take It to Heart?

The January Barometer has an impressive track record (if you listen to the guys who invented it). According to the Stock Trader’s Almanac:

Devised by Yale Hirsch in 1972, the January Barometer has registered eleven major errors since 1950 for an 84.5% accuracy ratio.

What they neglect to mention is that between 1945 and 2021, the stock market generated a positive annual return 70% of the time. So the question is, does a rally in January actually predict further strength? Or are these January “signals” just part of a larger bull market?

It’s a basic fact of trading that the market goes up 80% of the time in general. (That’s why I always urged my trading students to avoid the short side.) A better interpretation might be that a higher January warns against “fading,” or going against, the trend.

That said, we’re currently in a bear market. So a higher close this January may be worth watching, if only to see how the hypothesis plays out.

On the other hand, there are other, more important factors you should be aware of that could drive a rally this year. I’m going to share a couple in your next letter.

Make the trend your friend,

Bob Byrne
Editor, Streetlight Daily