Will the January Barometer Deliver This Year?

By Jeff Saut  FEB 04, 2013 9:45 AM

With the S&P 500 up for the month of January, it's worth revisiting the old stock market saying, "So goes the first week of the new year, so goes the month and so goes the year."

 


It’s that time of year again when the media is abuzz with that old stock market saying, “So goes the first week of the new year, so goes the month and so goes the year.”  With the S&P 500 (INDEXSP:.INX) better by 2.17% over the first five trading sessions of this year, and up 6.10% for the month of January, it is worth revisiting the January Barometer.  Devised by Yale Hirsch in 1972, the January Barometer states that as the S&P 500 goes in January, so goes the year.

According to the Stock Trader’s Almanac (as paraphrased by me):

Speaking to the first week of the new year, the last 39 “up” first five days of the year were followed by full-year gains for the year 33 times for an 84.6% accuracy ratio.  The average gain in all of those years was 13.6%.  As for the month of January, the indicator has registered only seven major errors since 1950 for an 88.7% accuracy ratio.  . . . Including the eight flat-year (minor) errors (less than +/- 5%) yields a 75.8% accuracy ratio.

In addition to that, the equity markets have a bullish tilt 67% of the time.  Therefore, the first week of the new year typically gives the January Barometer a bullish start for the month; 2013 is no exception.  Indeed, this year’s “lift off” actually began on December 31, 2012 with a 90% Upside Volume Day followed by another such day on January 2.  As chronicled at the time, back-to-back 90% Upside Volume Days are pretty rare, especially at the beginning of the year.  In fact, my notes show the last time that happened was in 1987 when the SPX was starting a rally that would carry it 24.7% higher by late March.  To reiterate, the performance of back-to-back 90% Upside Days since 1950, one month later the SPX is better on average by more than 6% some 83% of the time and up 12.8% (on average) three months later 100% of the time.  This is one of the reasons I have been adamant that any pullback was for buying.  Yet, there is another tried and true indicator to be considered.  Again, as scribed by the astute Hirsch Organization:

When the Dow closes below its December closing low in the first quarter, it is frequently an excellent warning sign.  Jeffrey Saut, managing director of investment strategy at Raymond James, brought this to our attention a few years ago.  The December Low Indicator was originated by Lucien Hooper, a Forbes columnist and Wall Street analyst back in the 1970s.  Hooper dismissed the importance of January’s first week as reliable indicator.  He noted that the trend could be random or even manipulated during a holiday-shortened week.  Instead, said Hooper, "Pay much more attention to the December low.  If that low is violated during the first quarter of the New Year, watch out!"

In the current case the December low for last year was 12938.11.  Alas, it feels like yesterday when Lucien imparted the December Low Indicator to me at “Harry’s at the Amex Bar & Grill” back in the ‘70s.  I miss Lucien, but I never forgot his indicator, yet I seriously doubt if it comes into play this year.  Therefore, I return to a variation of the January Barometer compiled by the Hirsch organization, which combines the Santa Rally, the first five trading days of the new year, and the January Barometer.  When all of those indicators are positive, like they are currently, the average gain over the ensuing year is 17.4%.  That said, there is one problem with this trifecta -- it includes the performance of the month of January.  Since investors have to wait until the end of January to see what the January Barometer “says,” one has to wonder what the gains look like excluding January’s performance.  While I have not done the work, using the Hirsch Organization’s numbers, a cursory analysis look like the following:

Since the average yearly gain with all three indicators positive is 17.4%, subtracting January’s 6.10% gain from the average gain of 17.4% produces an average return of 11.3% between February and the end of the year.  Plainly that’s good, but not the great return of 17.4% if January’s performance is excluded.  Nevertheless, January 2013 is in the “books” and at up 5.8% goes down as the best starting month of the year for the Dow Jones Industrial Average (INDEXDJX:.DJI) since January 1994.  Regrettably, after 1994’s January Jump of 5.97% the Dow stuttered-stepped through the remainder of the year at the “flat line” as the Federal Reserve began a series of six “rate ratchets” that would leave the yield on the 30-year Treasury Bond above 8%.  Schizophrenically, I have shifted from the S&P 500 to the Dow Jones Industrials because some really important events occurred last month for the two senior indices.

First, the economically sensitive Dow Jones Transportation Average (INDEXDJX:DJT) recorded a new all-time high, which is pretty interesting given last week’s negative “print” in GDP.  Second, the D-J Industrials registered a new bull market reaction high when it bettered its October 5, 2012 high of 13610.15.  With that, most Dow Theorists declared a Dow Theory “buy signal” since both averages made new highs.  I, however, only gave a half-hearted “buy signal,” believing said signal would be much stronger if the Dow could best its respective all-time high of 14164.53 of October 9, 2007 like the Trannies did on January 15, 2013.  Such an upside confirmation would also reinforce my sense that we are potentially in a new secular bull market.  Unsurprisingly, given the January Jump, as of last Friday’s close the Dow is only 154.74 points away from an upside confirmation.  If that happens, it would break the stock market out of its 13-year wide-swinging trading range much like what occurred in August of 1982 following that 17+ year wide-swinging trading range so often referenced in these missives.  Likewise, it would clear up any doubts about a Dow Theory “buy signal.”  Moreover, the set up looks about right for that to happen.

To be sure, the ongoing stock market strength has been driven by six metrics: 1) liquidity; 2) the housing recovery; 3) an improvement in bank lending; 4) better government finances; 5) strengthening employment; and 6) the fact that our government has become a little bit less dysfunctional.  Manifestly, if we achieve a more collegial environment inside the DC Beltway, as I have expected, we should be able to put the twin Armageddons behind us (fiscal cliff / debt ceiling-sequestration).  If so, investors will have to start focusing on the improving fundamentals; and here the news is getting better.  For example, despite all of the worries about waning earnings momentum, the percentage of companies beating their 4Q12 estimates is 63.1%, while 62.2% are beating revenue estimates.  Looking at the sectors reveals that the consumer discretionary companies are beating earnings estimates at the highest rate (75%), while consumer staples stocks are the worst at +11%.  And that, ladies and gentlemen, is one of the reasons I have been saying that I like all the sectors except consumer staples.  This morning, however, I want to focus on health care.

I have liked select health-care stocks for awhile on the theme that certain companies would benefit from Obamacare.  Drug stores were consistent with that theme since with 30 million more people becoming insured, foot traffic would increase not just for prescriptions, but ancillary items as well.  At the time our fundamental analyst’s (John Ransom) favorite name was CVS (NYSE:CVS).  Now he favors 2.8%-yielding Walgreen (NYSE:WAG) as he writes:

Based on potential EPS power of $5.24-5.55 per share in FY16, the stock currently trades at a 7.0-7.5x multiple.  As confidence in the consolidation story increases and the company begins to realize synergies (from the Alliance Boots acquisition), we expect significant multiple expansion.  By FY15 (with the stock trading on FY16 estimates), we expect multiples in line with the historic industry range of 11-13x P/E, or ~$65.00 at the midpoint; discounted back two years (at 10%), this suggests a stock price above $50.00. 

The call for this week:  Today is session 23 in the typical 17- to 25-session duration of a “buying stampede.”  Such skeins only have one- to three-session pauses or pullbacks before they exhaust themselves on the upside.  While a few have lasted for 25-30 sessions, it is very rare to have one last for more than 30 sessions.  That said, this one feels like it will extend toward the State of the Union address slated for February 12.  That address will likely be viewed negatively by the equity markets, which should serve to finally bring about a 5-7% correction.  How the stock market reacts following such a pullback will tell us a lot about the market’s future direction.  In the interim I favor the upside with the caveat that this rally is long of tooth.
No positions in stocks mentioned.

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