Betting Against the January Barometer

(MoneyWatch)  Following conventional wisdom on the markets will always be conventional, but often unwise.

A classic case in point: The January Barometer -- the popular belief that as stocks perform in January, so they perform for the rest of the year. After the worst-ever opening month in the eight-decade history of the Standard & Poor's 500 index, which lost 8.6 percent, many forecasters pointed to the barometer as a harbinger of a grim 2009.

They looked pretty smart in February and downright ingenious in early March, as stocks continued to hit multiyear lows. But they may be proven foolish as the months go by. It turns out there is less to the January Barometer than there seems, and what value it provides is often lost on investors who misinterpret it.

Fair-Weather Friend
True enough, the barometer is right about two-thirds of the time, but that is no great feat. As James Stack -- editor of InvesTech Market Analyst, an investment newsletter with a strong long-term track record -- notes, stocks have a winning year about two-thirds of the time.

All you have to do is get your prediction in early and call for a rising market at the start of January. Your forecast stands almost as good a chance as being right as the January Barometer a month later.

Think of it this way: If you live in Southern California and eat breakfast on most mornings, you would be right in thinking that if you eat breakfast, the sun is likely to shine in the afternoon. That does not mean that you need an umbrella if you skip the most important meal of the day.

What holds for the Cheerios Barometer also applies for the January Barometer. As Stack notes, when stocks have lost ground in January, the rest of the year has been down just 48 percent of the time. It's a tossup.

Contrarian Wisdom
Actually, Stack suggests betting against the January Barometer this year. It turns out that in the five worst Januarys that the S&P 500 turned in before the record-breaker this year -- 1939, 1960, 1970, 1978 and 1990 -- the rest of the year was higher.

Why the rebounds? The market's upward bias in January is so strong that a steep loss is evidence of capitulation from bulls after a long decline. Once they sell, the way is clear for a rally, maybe not right away but before the year is out apparently.

Stack, a very cautious investor who has built a career out of breaking with the Wall Street consensus, is preparing for a repeat performance. He has grown more bullish as the market has fallen, raising his model portfolio's allocation to stocks to 70 percent from 45 percent near the top in 2007.

Max King, a strategist at Investec Asset Management, has a similarly hopeful take on the January Barometer and the tendency for stocks to rise after a dismal opening month. He sees it as one of several signs that a significant bottom is near.

"The risk of new lows will remain until there is evidence of economic green shoots in the U.S. and of a reduction in the downward momentum of earnings," King conceded in a recent note to investors. But he advised that "such a setback should represent a once-in-a-generation buying opportunity, so much so that it may not be worth the risk of missing out by waiting for a setback that probably won't happen."

Barometer image by Rob Gallop, CC 2.0