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A couple of days ago I wrote about the possible impact of the sharp drop in the ISM index. While the unexpected large fall caught investors off guard, history points out that equities have performed better than average in the six months following a fall in the ISM index of five points or more. This result contrasts with 'general knowledge' that large drops in the ISM index are bad for equities. Today I take a look at another 'rule' that investors have been pointing out lately; 'As goes January, so goes the year'.

January negative one in every three years

The 'as goes January, so goes the year' phrase implies that the return on the stock market in January is a bellwether for the rest of the year. And since this January turned out pretty awful for equity investors the outlook for the rest of the year should be grim as well, according to this rule. Let's find out if this is true or not.

I use S&P 500 index price data (NYSEARCA:SPY) since 1928 to get a grip on the 'as goes January, so goes the year' adage. In the 86 calendar years since 1928 31 of those started with a negative return in the first month. The 31 years represent 36% of all years in my sample. So, roughly in one out of three years January turns out to be a negative month for equities. And that return is quite significant as well. In years when the stock market went down in January , the average return has been -3.8%. This is pretty bad, especially when you take into account that this is roughly half the historical average return per whole calendar year.

So not goes the year

But let's turn back to the main question. What does a negative return in January mean for the return during the rest of the year? The answer is shown in the graph below. In years where January turned out negative the return for the rest of the year has been 1.7% on average. Yes, only 1.7%. However, while this is certainly not impressive, it does not comply with the 'as goes January, so goes the year' rule. On average the return in the rest of the year is positive, NOT negative. That said, out of the 31 years in which stocks went down in January, there were 14 years in which the return in the rest of the years was also negative. That is a historical probability of 45%, which is significantly higher than the overall probability of any year to yield a negative return (33%).

(click to enlarge)

The chart also shows the average return for the whole year (including the first month) for years in which January turned out negative. In almost 60% of those years the whole calendar year turns out to be negative as well. The average return in these years is -2.3%. Compared to the average calendar year return for all years since 1928, which has been 7.5%, this is substantially lower. Hence, years which start with a negative return in January are on average bad years for equities. But, the investor adage 'As goes January, so goes the year' does not apply for years that start of negative. While small, the return in the remainder of the year has historically been positive, not negative as the rule would imply.

Source: As Goes January, So Goes The Year?