At the beginning of a year, Wall Street people are always talking about some folk lores that will predict the performance of stock market in the coming year. Under the current unsettled condition, people are naturally even more attuned to such folk lores. Those folk lores usually use correlations like, “If event X happens, stock market will go up or down in the year with an accuracy of more than Y %”. Of course, such correlations do not mean the existence of any logic to connect event X with stock market performance in the year. For example, we do not find any logical explanation for the connection between “which team wins Super Bawl” and the performance of stock market in the year, so we do not bother to study such correlations. However, among those folk lores there is one, the “January Barometer”, that we see some logic in the connection. We have made an in depth study of this “January Barometer”, and the results are presented in this comment.
The folk lore of the “January Barometer” says that the stock market in the year will follow its January performance. We use Dow Jones Industrial Average1, abbreviated as DJIA, as the representative of US stock markets. The percentage change of DJIA in a year, calculated from its opening price and its closing price of the year, is plotted as the blue curve in the graph at the right, covering years from 1929 to 2008. The scale of this blue curve is shown in blue at the left margin of the graph. The raw data of DJIA are from the financial sector of the website of Yahoo. The percentage change of DJIA in each January is plotted as the red curve in the graph, with the scale written in red at the right-hand-side of the graph. If the blue point and the red point of a year are both in the positive territory or both in the negative territory, the “January Barometer” is deemed to be successful. If one of the red and blue points is in the positive territory and the other in the negative territory, the “January Barometer” is deemed to have failed. For the cases of failure, the red points are marked with a green circle. Among 80 pairs of red and blue points in the graph, there are 17 failures. Among the 63 pairs of successes, 43 are “bullish” cases with both the red and the blue points in the positive territory, and 20 are “bearish” cases with both the red and the blue points in the negative territory. Among 17 failed cases of the “January Barometer”, 9 red points marked with the green circle are in the positive territory and 7 of such red points are in the negative territory.
The successes of the “January Barometer” are due to the market momentum, that is, once the market sets a direction in January, it just keeps going along the direction through the whole year. The interesting feature of the “January Barometer” is rather to study the years of failures, and ask why the barometer failed in those years. The most notable feature of the graph is the four consecutive failures at the left most portion of the graph; those red points with green circles are marked as “A1”, “A2”, “A3” and “A4” respectively. “A1”, the performance of DJIA of January, 1929, was recorded nine month before the crash of 1929. The 1929 crash occurred in October of 1929, stock market changed direction abruptly and closed down sharply by the end of that year. The consecutive failures of the barometer at 1930, 1931, and 1932 are striking. Either investors became so desperate in the Great Depression that they spontaneously rushed into stock market at the first months of the years with the hope that a new year would bring the turn around of fortune, or some pool operators deliberately set up rallies, using the special aura of January, to induce investors to jump in so that they could sell short, and then let the market collapse as the years advanced and the bad news from the real economy continued to stream in.
The failures of the barometer in the years with the red points labeled as “B1”, “B2”, ... , “B6” are not difficult to explain. Preceding those failed years DJIA's performance had deteriorated substantially, so it is no wonder that DJIA fell in those Januaries. However, during those years the real economy and DJIA had staged dramatic reversals and DJIA ended to be up at the ends of those years. Thus the “January Barometer” failed in those years. For the years, the red points of which are labeled as “C1”, “C2” and “C3”, similar explanations as for “B1”, ... , “B6” apply, but with bullish implications replaced by bearish outcomes. The years labeled as “A5”, “A6”, “A7” and “A8” are difficult to explain, so they are grouped together with “A2”, “A3” and “A4” as “unexplained”.
We are naturally most concerned about the right most blue point of 2008, and two right most red points of Januaries of 2008 and 2009 respectively. DJIA was down by 4.6 % in January of 2008, and was down by 33.8 % in the whole year. In the graph the blue point of 2008 was below the red point of the same year. There were quite a few red points in the graph that were as negative as or more negative than the red point of 2008, but in none of those cases the corresponding blue points were below the red points. This means that the real economy and DJIA had turned around dramatically during those years in contrast to the miserable year of 2008. If there had no manipulations during the Great Depression, points “A2”, “A3” and “A4” would have been in the negative territory and would have looked like the case of 2008.
The miserable performance of DJIA in 2008, that is, down by 33.8 %, is at par with the performance in 1930, and is surpassed only by the performance of DJIA in 1931, down by 52.7 % in that year. After such a strong down trend in 2008, it is no wonder that DJIA has dropped 8.8 % in January, 2009. The tendency of stock market to follow its own momentum implies that the market will continue down for a while in 2009. Whether it can turn around in 2009 and will end up in the positive territory by the end of 2009 depends on whether the real economy will bottom out in this year. As has been demonstrated in Comment 64, DJIA always bottomed out after the nadirs of the real economy were reached, but not in anticipating the bottom of the real economy as folk lores of Wall Street claim. Readers interested about the definition of the nadir of recessions are referred to article 12 for details. In general the high success rate of the “January Barometer”, about 80% success rate, only means that the dramatic turn around of the real economy is much rarer than the normal momentum following. This is an obvious and logical conclusion, but offers not much far sight into the question when the nadir of this recession will be reached.