But how accurate can a catchy saying be, you may ask? Well, according to Jeff Hirsch, publisher of the Stock Trader’s Almanac, since 1934 this barometer has had an 88 per cent accuracy rate in predicting how the rest of the year will fare.
Some dismiss “The January Barometer” as a statistical coincidence, but its track record is impressive. When you consider some of the other factors at play this year – it is now 83 months since there has been a significant correction in stock markets (the historical average is 42 months); stock valuations and fundamentals (such as earnings) are pointing to lower equity prices; a number of technical indicators used by stock analysts are now saying “sell”; and worrying geo-political and other negative global macro factors are not offering signs of optimism – maybe that indicator pioneered by Hirsch’s father is not looking so coincidental, after all.
It was certainly a rough month for global stocks, including being officially one of the worst starts to a year ever for the Dow Jones Industrial Average, which has surprised the investment community. Typically, January sees stock prices rise more than any other month for two main reasons: 1) people invest money from their end-of-year bonuses, and 2) those who liquidated investments in December for tax purposes tend to reinvest their money after the start of the year.
This seasonal anomaly is called “The January Effect” (not be confused with the barometer of the same name), but it has not happened in 2016. Instead, we started with a rout. Interestingly, and related to seasonal investment behaviour, the Christmas period also did not offer up the usual “Santa Claus Rally” in stocks, which normally occurs over the festive period. Perhaps the drop in the Dow Jones and S&P 500 in December were a harbinger of things to come.
In January, Chinese stocks were the centre of attention for most of the month, with some analysts calling the slowdown in China the catalyst for declines across the rest of the world. Chinese shares have fallen over 20% from their recent highs, and there are fears the country could even fall into recession in 2016. With China now a major global player, its problems at home could create far-reaching negative consequences globally.
Japanese shares have also fallen 20% from their highs, but then Japan has been mired with problems since its own major bubble burst in 1990. Of greater concern is that Europe, emerging markets and pretty much every sector have also joined the US and China in having a terrible start to the year.
Elsewhere, oil prices remain low, but that is a double-edged sword. On the one hand, low gas prices mean consumers have more to spend, which should boost the economy. On the other hand, if the future looks bleak, families may choose instead to pay down debt and/or save their money instead. With sanctions now lifted, production from Iran could create a potential new flood of oil, which could continue to suppress prices for the foreseeable future.
Then, of course, the Federal Reserve raised interest rates in December. Although only a small increase, investors have nevertheless poured into US treasuries, sucking money out of the stock markets. It has been suggested, with so many cracks appearing in the US economy, that tightening monetary policy was ill-advised, and that the US could also find itself on the verge of a slowdown.
Is the worst of it over yet? Discerning investors will have already hedged their portfolios or reduced equity exposure altogether, while those who have been sitting on the sidelines may be preparing to go “bargain hunting” in the markets soon. But if this current sell-off keeps gaining momentum, the January Barometer tells us there is an 88% chance that 2016 may not be a pleasant year for stock markets.
One asset class that prospers in these conditions is Trend Following, most commonly used by commodity trading advisors (CTAs). CTAs rely on risk-managed computer algorithms to follow trends – whether up or down – in a variety of different markets, and the current environment is providing perfect conditions for them to make money.
Because CTAs can make money in all market conditions, and because markets move down faster than they move up, as this downside pressure continues, that barometer may be indicating a stellar few months ahead for trend followers.
If you would like to learn more about stock market investing, please feel free to contact us at: chatwithus@phuketexpatfinance.com