Dorfman: January barometer no real key to stock market direction for full year

In its crudest form, the January barometer theory states that the direction of the stock market in January predicts its direction for the full year.

Of course, January is itself part of the year it is supposed to predict. Therefore, the more sophisticated question is: Does January predict the next 11 months?

To some degree, it does. According to Ned Davis Research, from 1950 through 2014, when January was up, the Standard & Poor's 500 Index gained an average of 12.4 percent in February through December.

By contrast, when January was down, the next 11 months' gain averaged only 0.58 percent. Thus, a bad January tends to pre-sage a mediocre year, and a good January a peppy year.

The trouble is that there are many exceptions, including several recent ones.

Last year, January was down 3.56 percent, but the market rose 15.5 percent for the remainder of the year. (These figures do not include dividends.)

In 2011, January was up but the market ended the year down (flat with dividends).

In 2010, a weak initial month was followed by a gain of more than 17 percent over the remainder of the year.

And in 2009, an 8.57 percent decline in January was followed by a surge of 35.02 percent the rest of the year.

In short, the January barometer has been wrong in four of the past six years.

Looking for clues

For people who like to find hidden meanings in the January price action, this January has offered few clues.

Through Jan. 23, the S&P 500 is down 0.34 percent. Stocks fell on the first three trading days, rose twice, then fell for five days in a row, hitting a low of 1992.67 on Jan. 15.

Then shares rallied, rising in four days out of five last week.

What does that all mean? Probably nothing at all.

I look for my clues elsewhere. The economic recovery is gathering steam, the fall in oil prices is a plus for most people and the third year of an election cycle is usually good.

On the negative side, stocks look a little pricey, and the Federal Reserve will probably raise interest rates this year.

Balancing the pluses and minuses, I expect a moderate up year in 2015.

‘January effect'

Besides the January barometer, there is also the famed “January effect.” This is really the confluence of three effects. Stocks in general tend to rise in January. Small stocks often jump. And last year's losers frequently make at least a temporary comeback.

But the January effect this year is feeble, perhaps nonexistent.

As we've already seen, there has been no January bounce in the overall market.

The traditional strength in small stocks has likewise been absent. A widely followed small-stock index, the Russell 2000, is down 1.28 percent through Jan. 23.

And what about last year's losers? The theory is that investors dump their losers in the fourth quarter to establish tax losses. In January, tax-motivated selling abates, and the previous year's dogs often revive.

This year, the 2014 losers haven't rebounded as they are supposed to.

Losers' lament

I compiled a list of 10 stocks in the S&P 500 that got a thrashing last year, even though the market was up. All of these stocks were down at least 13 percent in 2014; many were down much more. I took care not to overload the list with oil and gas names, which still appear to be in free fall.

The 10 were Amazon.com Inc. (AMZN), Apache Corp. (APA), Coach Inc. (COH), Discovery Communications (DISCA), Fluor corp. (FLR), Flowserve Corp. (FLS), Joy Global Inc. (JOY), Mattel Inc. (MAT), Wynn Resorts Ltd. (WYNN) and Xilinx Inc. (XLNX).

The new year didn't bring new life to these shares. Seven of them declined further from Jan. 1 through 23. The average return for all 10 was a loss of 5.8 percent.

My own “January rebound” candidates, which I wrote about on Nov. 18, 2014, didn't fare much better. My five choices — Coach Inc. (COH), Conns (CONN), Hangar (HGR), Rowan (RDC) and Pier One (PIR) — averaged a 2.8 percent loss this January.

The moral of the story is that investors should probably forget everything they've learned about special market dynamics in the month of January. I'm sure the traditional patterns will reassert themselves sometime, but they are not consistent enough to be really useful.

Instead, investors should buy shares in companies that have a competitive advantage, whose leadership has a sound plan and whose stock is reasonably valued. Then, hang on through the turbulence.

John Dorfman is chairman of Dorfman Value Investments LLC in Boston and a syndicated columnist. He can be reached at jdorfman@dorfmanvalue.com.