Popular Stock Market Indicator Calls For Big February Gains

Stocks have shot higher to begin 2018. The S&P 500 Index (SPX) is up nearly 4% in the first 10 trading days of the year, giving it its best start since 2003. This is a good sign based on the popular January Barometer, which asserts that no matter how January fares, the rest of the year will follow. Below, I run the numbers for the January Barometer and break them down to relate to the current trading environment.

Barometer Breakdown

The numbers below are the essence of the January Barometer. Over the past 50 years, when the S&P 500 was positive in January, the rest of the year averaged an additional 11.37% and was positive 86% of the time. When the first month of the year has been negative though, the rest of the year has averaged a gain of just over 2% and was positive 64% of the time. So, January has been a pretty good indicator for the rest of the year.

The January Barometer has been even more reliable as a short-term indicator. When the S&P 500 had a positive January, the month of February averaged a gain of 1.23%, with 71% of the returns positive. Furthermore, when January has been negative, February has been overwhelmingly negative as well. Only 36% of the returns have been positive, while February averaged a loss of 1.10%.

However, the good news isthat January of this year is looking to be an especially strong one for stocks. Looking at extremely strong and weak January returns makes the January Barometer even more pronounced. When the S&Phas gained at least 4% in January (currently, the index is up about 3.9%) the rest of the year has been positive over 90% of the time. On the opposite end, when the SPX has been down 4%, the rest of the year has been positive just 60% of the time.

When looking at just February, the index averages a gain of over 1.6% when the January return is greater than 4%, and has been higher 69% of the time. When January is negative 4% or more, though, the next month averages a loss of 1.72% and has been positive just 30% of the time.

When Optimism is Already High

Given the trajectory of the market recently, it's no surprise that optimism is at an extremely high level. This is based on the weekly sentiment survey conducted by Investors Intelligence. The poll examines investor newsletters and determines the percentage that are bullish or bearish (they also have a third designation of those expecting a short-term correction but longer term bullish). According to that poll, 64.4% of the newsletters are bullish and just 13.5% are bearish so the difference is more than 50%. It's the highest reading since 1986.

Does this contrarian indicator diminish the January Barometer? I would say it doesn't completely negate the January Barometer, but it might cause you to temper expectations. Historically, when January has been positive but the bulls minus bears percent in the Investors Intelligence poll is over 30%, the rest of the year has averaged a return of about 8%. That's an acceptable return but otherwise, the rest of the year has averaged a gain of about 15%.