Can January forecast the stock market?

There is a traditional market belief that the performance of the stock market in January can predict the direction of share prices for the rest of the year.

This means that, if we are going to follow this theory, we should all hope that the market will end this month on a positive note so that the PSE Index will end the year higher.

Otherwise, if it fails to gain in January, we will all be doomed with the prospect of a falling market this year.

According to legendary market guru, Yale Hirsch, who first developed this indicator known as the January Barometer in his book “The Stock Trader’s Almanac” in 1974, this theory has an accuracy rate of 83 percent based on the historical performance of the S&P 500 index.

In the past, several studies have attempted to explain the reasons behind this anomaly, but no conclusive justifications have been made.

The closest explanation for this occurrence may be the fact that major marginal players in world equity markets are also the major institutions.

Every February, the investment committees of these institutions will review the results of the performance of their funds in January before they launch their new funds during the year.

Because they need to identify the right sectors where they need to allocate their resources quickly and efficiently, most decision makers will simply apply the strategies that have proven to be successful in January, setting the mood and direction for the market.

While this indicator may be applicable to the US market, how reliable is this for Philippine stocks?

If we will look at the past data of the PSE Index and compare the returns of January with the rest of the year annually from 1988 to the present, we can see that the effectiveness of this indicator has been declining through the years.

For example, during the period 1988 to 1992, the January barometer could predict the direction of the market in the remaining 11 months of the year in 64.3 percent of the time.

But this would gradually decline to 60 percent in the next 20 years from 1992 to 2010 before dipping further to 30 percent in the last 10 years from 2010 to 2019.

In total, given the 32-year period from 1988 to 2019, the success rate of the January barometer was only 56.3 percent.

It is interesting to note, however, that an up market in January is a better predictor than a down market.

Historical data shows that a positive closing in January has a 66.7-percent chance of leading the market higher by year end compared to a negative return, which has only 36.4 percent batting average.

The average gain of a positive January yields a year-end return of about 6 percent for every 1 percent gain during the month, while a negative January, on the other hand, gives up about 4 percent for every 1 percent loss.

The lower accuracy rate and smaller average loss of a down market in January simply mean that the general bias of share prices is always upward.

It also means that the January Barometer, which suggests that as January goes, so goes the whole market year, may not hold true anymore.

This is probably because there are many factors affecting the market that are constantly changing. Rising global market risks brought about by evolving economic environment has resulted to increase in volatility, as well as valuation.

Although a positive January is more reliable than the barometer, it is always better to use this as a guide rather than as a strategy in making your investment decisions. INQ