examining the “January barometer” and the “First five days of January indicator” for indications of bullishness
Even over time spans of up to a year, the market’s short-term moves are generally unpredictable.
The January fluctuations of the U.S. stock market thus far provide very little insight on the performance of stocks during the remainder of the year.
When it became clear last week that Wall Street’s so-called Santa Claus rally period, which runs from Christmas through the first two trading days of January, would be a bust, I alluded to this conclusion. Since there is no statistically significant correlation between the stock market’s performance at this time and the direction of equities over the next year, I stated that the market’s loss during this time was not reason for alarm.
Therefore, the anticipated 2025 return on the stock market was neither more nor lower than typical, even if Santa did not visit Wall Street. However, a “average” return is not a compelling story, and Wall Street loves to tell bullish tales. In order to discover an indicator that confirms their bull-market theory, the bulls have simply turned their focus to other early-January data.
Now, they are concentrating on purported trends like the “January barometer” and the “first five days of January indicator.” The former holds that the market’s movement during the first five trading days of the year predicts the market’s movement throughout the whole year. The latter claims that this predictive power extends to the market’s direction for the entire month of January.
According to the chart above, the Santa Claus rally has statistical significance that is just marginally greater than that of these other indicators. Since its inception in 1896, the Dow Jones Industrial Average (DJIA) has served as the basis for the statistics presented in the table. As you can see, only one of these four—the January Barometer—has a history of significance at the 95% confidence level that statisticians frequently employ to determine if a trend is real.
Furthermore, we can’t determine anything about the market’s future trajectory from any of the four indicators, even the January barometer. The low r-squared of the indicators, which gauges how well each can explain or forecast the path of the market from February to December, reveals this. Even the January barometer’s r-squared is less than 3%, which indicates that almost all of the variance in the stock market’s performance from February to March is unrelated to its January performance.
Examine the years when the Dow fell during the Santa Claus rally period, the first five trading days of January, and the full month of January, the three early-January indications. During these years, the stock market increased 73% of the time from February to December. The 75% chance of a rising market during each of these three early-January periods is hardly different from that. This is one of the reasons the composite indicator, which combines the three early-January indications, has such a low r-squared.
Examine another indicator based on the average household’s equity allocation to put these indicators’ low r-squared into perspective. In my recurring writings on the valuation of the stock market, I discuss this signal among others. When forecasting the recovery of the stock market in the following year, its r-squared is 7.1%, which is nearly three times greater than that of the January Barometer. As I mentioned in late December, this valuation indicator is predicting a return for the U.S. stock market that is much below normal over the next few years, which is bad news for bulls.
A 7.1% r-squared is still low, to be sure. This illustrates the fact that, even over time spans of up to a year, the market’s short-term moves remain essentially unpredictable. However, the indications based on early-January gyrations stand out as particularly useless even among these numerous indicators that make an effort (usually in vain) to predict the market’s short-term direction.
The bottom line? The stock market’s current performance will hardly affect how it performs this year. You have much more important things to think about than these gyrations in early January.
