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Is the January barometer providing an early warning for 2016 equity returns?

The only sure thing for 2016 is volatility. China Daily/Reuters

Is the January barometer providing an early warning for 2016 equity returns?

The only sure thing for 2016 is volatility. China Daily/Reuters

So far, it has not been a happy new year for equity market investors. The Australian equity market lost A$100 billion in market value in the first week of trading, mirroring a dire global trend.

If we are are to believe the “January barometer”, things may be about to get worse. The January barometer is based on the belief that when the equity market ends in the black for the month of January, the subsequent year will be prosperous for equity markets, while a negative equity market return in January signals a bearish year for stocks.

The barometer was first devised in 1972 by the editor of the Stock Trader’s Almanac, Yale Hirsch. Hirsch claimed that January returns could accurately predict subsequent equity market returns in 91.1% of years, with the rare failures of this indicator being explained by extreme events such as wars.

If the January barometer were as accurate as has been suggested then this indicator would provide a boon to investors who could use the signal to make asset allocation decisions for the subsequent year. Unfortunately financial markets are like discount airlines; there are no free lunches. Competitive market forces result in investors exploiting, and therefore eliminating, any opportunities to make risk-free abnormal profits.

The weight of academic evidence now shows that the evidence used to justify the January barometer was a statistical anomaly. The result does not appear to hold when a longer sample of years are analysed and there does not appear to be any evidence to support the January barometer outside of the US.

An examination of returns on the Australian equity market from 1974 to the present provides a further rebuttal to January barometer. The figure below provides annual average returns across the subsequent eleven months for years in which the return in January is positive and negative respectively.

Data used to create this chart was sourced from Datastream.