Our historical playbook analysis of what happens after the S&P 500 has outsized gains in January has worked almost every month this year. Abnormally strong January returns have been a historically clear signal about market direction over the balance of the year. Here’s an update of our analysis on how it has performed thus far in 2019 through September:
- The S&P 500 increased 7.9% during January this year, one standard deviation above this month’s average return of 1.2% since 1958 (first full year of data).
There’s only been 8 other Januaries that have also returned +1 standard deviation above the average, or 15% of the time: 1961 (+6.3%), 1967 (+7.8%), 1975 (+12.3%), 1976 (+11.8%), 1985 (+7.4%), 1987 (+13.2%), 1989 (+7.1%), and 1997 (6.1%).
- The S&P is higher most of the time every month on average from February through July after an especially robust January return. This year was no different as you can see in the chart following this piece. The only exception was in May when the S&P fell 6.6% due to trade concerns, but it rebounded by 6.9% in June and was also up 1.3% in July.
- Conversely, the S&P has experienced negative returns most of the time in August during these special “Strong January” years, down an average of 50 basis points. It was no surprise, therefore, that the S&P dropped 1.8% this past August as we had been warning clients.
- September, however, fared better than expected. The average historical return in “Strong January years” during this month is negative 0.1%, with the S&P lower +60% of the time. Last month, the S&P defied this trend with a +1.7% return.
Bottom line: most months this year have worked in line with historical averages. While the S&P’s September return beat expectations, it does give us some concern. There are only 3 other years in our “Strong January” playbook when the S&P had a positive return in September. When that happened, the S&P was always down the next month by 3.1% on average in October.
With that in mind, here is what typically happens in the following months based on years with especially large January returns:
- October (bad): The average historical return is negative 2.5% and the S&P was down +60% of the time. Excluding the stock market crash in October 1987, it was up an average of 22 basis points. The lowest return was -21.8% in 1987 and the highest was +6.2% in 1975.
- November (good): The average historical return is +1.3% and the S&P was higher 75% of the time. The worst return was -8.5% in 1987 and the best was +6.5% in 1985.
- December (really good): The average historical return is +2.8% and the S&P was higher 88% of the time. The weakest return was -1.2% in 1975 and the strongest was +7.3% in 1987.
The upshot: we expect a rocky October for US equity returns. Not only has September not set up this month particularly well relative to the “Strong January” historical data, but the VIX has peaked the most in October out of any month since its creation in 1990. Therefore, history points to above average volatility and likely a negative return for the S&P this month.
The silver lining: volatility usually calms down in November and December, when the S&P is typically higher the vast majority of the time during years with robust January returns. This return data also fits with our volatility work, as December is the quietest month of the year with the VIX having troughed 8 times during that month.
Looking at the bigger picture for all of 2019, here’s how the S&P has performed overall during years with abnormally strong January returns:
- Every “strong January” year except 1987 saw positive double digit annual total returns for the S&P: 1961 (+26.6%), 1967 (+23.8%), 1975 (+37.0%), 1976 (+23.8%), 1985 (+31.2%), 1987 (+5.8%), 1989 (+31.5%), 1997 (+33.1%). The S&P was even up in 1987, albeit by single digits.
The average total return for these years is 26.6%. This year, the S&P is up 17.3% YTD.
- The earliest month when the S&P reached its high for the year was in mid-July 1975, followed by late August in 1987.
The rest of years peaked in September or the fourth quarter. The S&P reached its highest level in September during 1967 and 1976. It also hit its high in early October during 1989, and peaked in December in 1961, 1985 and 1997.
In sum, you likely noticed that the eight years with unusually big January returns mostly occurred in mid-to-late cycle periods, similar to where we are now. Although October will likely be a tough month for US stocks, we still expect the S&P to end the year higher by double digits. The Fed will likely cut near-term rates again in December at the very least, and hopefully strong holiday consumer spending should boost sentiment.