Maybe it was the original U.S. Covid-19 lockdown that made “The Last Dance” the most-watched ESPN documentary of all time in April of 2020. More likely it was a bit of our collective hero worship. The focus, in this instance, was on the NBA’s GOAT—Greatest of All Time, Michael Jordan. That high viewership probably also had a lot to do with our starvation for new streaming content a month into the lockdown…But back to Jordan and his exploits.
Why is Jordan the GOAT? He was the best offensive player ever and averaged more points per game (30.12) than anyone over his career. He was ALSO one of the top defensive players ever as well, tied for most times selected to the All-Defensive First Team—nine times. Those accomplishments alone would be enough to make him the best player in the game, but GOATs need championships to solidify their place at the top. And Jordan has unparalleled credentials there. He played in six NBA championships. He won six championships. And he won six championship Most Valuable Player awards. Enough said, right? But it was Jordan’s late career that parallels with our investing indicator myth-busting today.
His Final Shot
Michael Jordan took his final shot as a pro basketball player in April of 2003. The shot was a free throw that didn’t really have any bearing on the game and his team lost by a wide margin. But because it was the last shot by the greatest NBA player ever, it was still noteworthy. Thanks to some shrewd planning on my part, I was sitting in the stands with my 10-year-old son at the old Spectrum arena in Philadelphia. Every local luminary was also in attendance that night, wanting to witness a bit of history and wish farewell to a basketball legend.
I still remember that on our way in, someone offered me $1,000 cash for our two tickets. But there was no way that I was going to let my son miss Jordan’s last game. He was a player who seemed to perform at superhuman levels, averaging over 30 points per game throughout his NBA career. Yet when we saw him in that last game, he was 40 years old and though still competitive (he averaged 20 points per game in his final year!), he was certainly a mere shadow of his younger self.
Like Michael Jordan playing pro ball at age 40, today we take a look at an indicator that seems to be past its prime as well. And, on its 50th anniversary no less! The well-known January Barometer seems to have lost its predictive powers, as we shall explore below. But first, let’s admit that there are…
Too Many January Indicators
There are many indicators flying around with the word “January” in the name so let me clarify which one we’ll be looking at today:
- The January Barometer was devised in 1972 by Yale Hirsch of Stock Trader’s Almanac fame, making this year the indicator’s 50th anniversary. It states that as the S&P 500 goes in January, so goes the year. We’ll look at some statistics for this once-impressive indicator below. And bid it a farewell.
- The First Five Days of January. This indicator (discussed in past years) holds that the first five trading days of the year predict the market action for the rest of the year. We’ve already busted that myth.
- The January Effect. This one is not an indicator but an observed phenomenon that small-cap stocks outperform the big caps in January. We described the merits of this observation back in an article in December and noted that the effect still exists, but really has moved to an earlier timeframe—the second half of December.
The January Barometer: Many Discuss It, Few Understand It. Don’t Trade It!
In the coming few days, as we head into the end of January, pundits typically write about the January Barometer in glowing terms. Don’t be sucked in by the hype.
On the surface, the January Barometer has had an impressive track record with an 84.5% accuracy claim over the past 71 years. That’s the number you’ll hear quoted over and over again. It is calculated quite simply: If January presents a positive return for the S&P 500, the January Barometer predicts that the full calendar year will be positive, and vice versa for a down January.
The indicator makes an exception for any year that the market moves less than 5% in either direction and calls that year neutral or flat. The flat year is then not counted for or against the track record (which is a reasonable exception). Given that caveat, the January Barometer has only been “wrong” eight times since 1951. The January Barometer used to do a credible job of predicting up and down years. For the last 2+ decades? Not so much.
If we break down the January Barometer signals into decades and see how many times it is correct out of the 10 years for a given decade, we start to see a problem. Let’s look at how many misses (an up January as part of a down year or vice versa) and how many flat years there have been per decade. Once we subtract misses and flat years from 10, the remaining years in the decade are the ones that the indicator can claim to be helpful:
As you can see, the usefulness or efficacy of the indicator has dropped off drastically in the last two decades. In fact, the indicator has only been useful in 8 years out of the last 21. This is not a statistically significant sample, but it does raise the question as to whether a once interesting indicator has any effectiveness in anticipating market direction, especially since I’d propose that more recent decades are the most relevant. As we shall see, the problem is even deeper. But we do need to pause and mourn the fact that a small down January in 2021 (-1.1%) would have had you flat the market for the rest of the year; making the indicator miss out on a +28.32% up move for February through December!
Perhaps there has been a change in the investment behaviors that drive markets and the tax selling of stocks in December, which turns into January buying, is no longer a significant factor. But regardless of whether underlying investing practices have changed, the structural nature of the markets has changed. The markets have become more volatile and large-scale direction changes occur more quickly and go further starting in the late 1990s. But let’s dig one level deeper into the logic flaw that makes the January Barometer a broken indicator.
The January Barometer’s Flawed Logic
The Stock Trader’s Almanac judges the January Barometer by using calendar year results when those gains (or losses) already contain the January returns. It’s a bit like saying that a football team that outscores its opponent in the first quarter is likely to win the game (or vice versa).
If you used the strategy to trade each year, you would have to buy on the first trading day of February and exit on the last day of December, sitting out the month of January each year. That strategy, over the last 21 years, results in a net loss of -5.57% per year (even though 2008 returned a whopping 40.1% return!).
The January Barometer may have had a good run “back in the day”, but in today’s faster news cycle-driven market, it’s not even useful for cocktail talk.
I’d love to hear your thoughts and feedback. Just send an email to drbarton “at” vantharp.com.
Great trading and God bless you,
D. R.