DEFINITION of January Barometer

The January Barometer is a theory positing that the movement of the Standard & Poor's 500 Index (S&P 500) during January sets the stock market's direction for the year (as measured by the S&P 500). The January Barometer states that if the S&P 500 were higher on January 31 compared to the beginning of the month, proponents would expect the stock market to generate positive results during the remainder of the year.

BREAKING DOWN January Barometer

If an investor believes in the ability of the January Barometer to predict the equity market's performance, he or she will only invest in the market in the years when the barometer predicts the market will rise, and stay out of the market when it forecasts a market pullback.

While the January Barometer has produced better than 50% accuracy rates during 20-year periods, it's difficult to produce excess returns by using it. This is because the improved performance by staying out of the market during bad times can be more than offset by larger losses incurred when the barometer incorrectly predicts a bull market.

There may be a reason positive January performance may be a strong harbinger of positive performance for the rest of the year. One reason may be the historical pattern of the stock market to rise. Stocks have finished higher in all but 16 out of 71 years since 1945. So then, it might not be surprising that stocks finish higher for the year so often despite either positive and negative Januaries due to this directional bias.

January Lessons

Momentum is one of the primary reasons some investors give credence to indicators like the January barometer. The thought process here is that a bullish start to the year will set the market in the right direction, propelling it throughout the year.

The January Barometer has generated mixed results in the past few years. In 2017, a 2% January gain for the S&P 500 preceded the 19% full-year rally. However, in 2016, the S&P 500 gained 11% for the full year, despite a 4% decline in January.

Now investors will have to analyze this past January's stock market performance when the market rose 5.6% — the 11th strongest since 1945 — and decide how to invest for the remainder of the year.