January was the market's best start to a New Year since 1997. The S&P 500 realized a total return (price appreciation and dividend income) of 5.2%. Had many companies not paid their traditional first-quarter dividend payments in December, the return would have been even higher.
Given this performance, should you buy stocks now?
If you believe historical correlations will continue to hold up in the future, the following data might give you an answer. Gains in January have traditionally led to full-year gains. Jeff Hirsch of the Stock Trader's Almanac says the "January Barometer" has only had seven major errors since 1950. Using data going back to 1945, Sam Stovall, the chief equity strategist for S&P Capital IQ, calculated an average 11.2% gain for the February through December period when the S&P 500 realized a positive return in January. Stovall also determined that the correlation between January gains and February through December gains held true 84% of the time. Ned Davis Research went back further to 1928. They found 17 occurrences when the S&P 500 gained 5% or more in January. The average 11-month gain following these strong starts was 6.9%, and positive returns were realized 70.6% of the time.
There is also a valuation argument to be made. As I tweeted over the weekend, 134 S&P 500 companies are trading below their five-year average price-earnings (P/E) ratios. About the half the index's member companies (244 to be exact) are trading below their five-year average high P/E. S&P Capital IQ sent out a report yesterday saying the S&P 500 is trading at 13.6x forecast 2013 earnings. (The firm thinks the index's earnings will total $109.96 this year, up from a projected $103.65 for 2012.)
Not everything is rosy, however, as there are clouds in the sky to keep an eye on. The pace of economic growth is slow. Consumer confidence plunged last month, as workers saw a higher level of payroll taxes deducted from their paychecks. The automatic budget cuts known as sequestration are still looming. Europe's economic and fiscal problems have not gone away.
In other words, the market will be up over the next 11 months, unless it's not.
As humans, we put a lot of weight on short-term events, even though we are investing for long-term goals. Portfolio allocations are intended to be maintained for the long term. On any given month or year, stock prices could be up or they could be down. Over the long term, however, stock prices rise. This is why the question you should be asking is not whether is now a good time to invest, but rather what is the proper allocation you should have to stocks? If the answer suggests you don't have enough allocated to stocks, then now is a good time to buy stocks. (Cash needed within the next few years should not be risked in stocks; grin and bear the low interest rates paid by money market accounts and certificates of deposits instead.)
But what if you are worried and don't want to incur a short-term loss? I'll share with you what I tell everyone who calls and asks whether they should get into the market. (I get asked this question frequently.) Put some money into the market now and then pick one or two dates on your calendar to invest the remainder of your money. When those dates are reached, invest the money no matter what is going on. The gradual movement into the market may be easier from an emotional standpoint, as opposed to fully investing in stocks at once, and you will still make progress toward your allocation goals.
Still worried? Consider this. If you bought stocks near the top of the Internet bubble, you still could have made money by staying in the market and reinvesting your dividends, as this study by Sam Stovall of S&P Capital IQ shows.
Charles Rotblut, CFA is a Vice President with the American Association of Individual Investors and editor of the AAII Journal.