Bad January, Bad Year? What History Says

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Bad January, Bad Year? What History Says

Friday triggered our S&P 500 “January Indicator” with the S&P 500 finishing down 1.1 pct last month. There’s an old Wall Street adage that the stock market’s performance during the first month of the year can predict whether it will be positive or negative for the entire year. The idea here is that a positive first month of trading usually leads to a positive annual performance, or vice versa.

Here’s a quick refresher from our earlier report on what the last 4 decades say about this theory:

  • The correlation between January’s returns and year as a whole is 0.41, or an r-squared of 16.5 pct since 1980 (actually pretty high for a simplistic one-variable model).
  • Since 1980, when the S&P has been positive in January it’s also had a positive annual return during 84 pct of those years (up 15.5 pct on average).
  • When the S&P has been negative in January since 1980, it’s had a positive return during 63 pct of those years (up just 2.2 pct on average).

The upshot: since 1980, when the S&P has a positive January its average annual return is 16 pct but when January is a losing month, the average annual return is only 2 pct. Given that January is unfortunately in the losing category this year, we have three follow up points that delve further into how the balance of 2021 could look against this backdrop:

#1: Since 1980, negative January returns have come in three levels of severity:

  • Very bad: down more than 5 pct (1990, 2000, 2008, 2009, 2016)
  • Bad: down between 2 and 5 percent (1981, 2003, 2005, 2010, 2014, 2015)
  • Slightly bad: down between 92 bps and 2 pct (1982, 1984, 1992, 2002)

Here’s how the S&P 500 performed during the balance of these years (end of January through December):

  • Very bad January returns: up 2.2 pct on average thereafter from February through December.

    This was balanced out by extreme rest-of-year returns in 2008 (down 34.5 pct) and 2009 (+35.0 pct).
  • Bad January returns: up 10.9 pct on average from the end of January through December.

    Stand out years include 2003 (+29.9 pct from February through December), 2010 (+17.1 pct) and 2014 (+15.5 pct).
  • Slightly bad: up 90 bps on average from February through December.

    The two outliers here include 1982 (+16.8 pct from February through December) and 2002 (-22.2 pct).

Takeaway: even when the S&P is negative in January, it’s been positive the rest of the year nearly three quarters of the time (73%) and up an average of 5.3 pct from February to December. As for whether a worse or better negative January return can predict the balance of the year, there’s outliers in each of the 3 tranches we highlighted depending on the market conditions at the time.

#2: This year falls into the “slightly bad” January camp in terms of negative returns (-1.1 pct). Here are the comparable years and their rest-of-year returns/historical backdrops:

  • 1982: S&P down 1.8 pct in January, and up 16.8 pct from February through December.

    Interest rates fell throughout 1982 and the US economy recovered from a recession caused by an oil shock and former Fed chair Volcker’s fight against inflation.
  • 1984: down 92 bps in January, and up 2.3 pct the rest of the year.

    Fed Funds rates rose during the first half of 1984 through August but fell thereafter. Important: the S&P had already been up 20.4 pct and 22.3 pct on a total return basis during the prior two years.
  • 1992: down 2.0 pct in January, and up 6.6 pct the rest of the year as rates came down quickly in the aftermath of Gulf War I. The S&P was also up +30.2 pct on a total return basis during the prior year.
  • 2002: down 1.6 pct in January and the S&P fell a further 22.2 pct through year-end. This came after the dot com bubble burst, the 9/11 terror attacks, and the lead up to the Iraq War.

Takeaway: 2021 differs from these periods in that interest rates are already low and will likely remain there, and traditional geopolitical concerns (i.e., wars) are not an issue. One similarity, however, is that we are coming off two strong years of returns, which brings us to our third and most important point…

#3: The S&P 500 was up 31.2 pct and 18.0 pct on a total return basis in 2019 and 2020 respectively, but it’s historically rare for the S&P to register 3 consecutive years of double digit returns. For example, out of the 19 times the S&P has had two straight years of double-digit returns since 1958 (first full year of data), the index only went on to produce a positive double-digit return for a third consecutive year or more during three periods (1963-1965, 1995-1999, and 2012-2014).

Takeaway: a third straight year of double-digit returns does not happen often. It’s much more common to see two consecutive years of double-digit returns sporadically sprinkled throughout a cycle.

Bottom line: we’ll never fully rely on just one indicator, but “so goes January so goes the year” is ingrained enough in investors’ minds that it’s worth putting in historical context. While January 2021 did not start off on the best foot, there’s more historical precedence for it to register a positive performance over the balance of this year than negative. US equities may not have the tailwind of falling interest rates, but they should have earnings leverage coming off the bottom of a cycle as Nick discussed in our Markets section of our full report. And even though it’s a tall order for the S&P to end 2021 up double digits for a third year in a row, low interest rates and improving corporate earnings power could still enable the index to produce the average rest-of-year return of +5 pct after its tough January.