How much does January matter for year-long stock performance?

The rally in US stocks slowed last month as the S&P 500 Index ended January up a modest 1.6%, following a whopping 8.9% gain this past November and 4.4% gain in December.¹ With US equities off to a more tempered start in 2024, discerning investors are left to wonder about two well-known phenomena regarding the first month of the year: the January effect and the January barometer.

What have equity returns the first month of the year historically looked like? Is stock performance in January indicative of what performance will be for the full year? The January effect and January barometer shed light on these questions. But do they create investment opportunities? Probably not.

What is the January effect?

On average, US equity returns have tended to be strongest in January, compared to the other 11 months. The trend has been especially prevalent among small-cap stocks.² Several theories attempt to explain why, including the impact of year-end tax loss harvesting, the flow of funds in the new year, and investor psychology. Interestingly, although the January effect was seen throughout the 20^th century, it has weakened substantially in recent decades.

What is the January barometer?

The January barometer refers to the fact that the S&P 500’s calendar year performance has matched the direction of January returns nearly 77% of the time.³ In other words, when the index rises in January full year returns tend to be positive, and when the index falls in January full year returns tend to be negative. This has led some to believe that when it comes to stock market performance, “as goes January, so goes the year.”

The full story behind January’s historical returns

Regardless of January’s historically strong returns and supposed predictive power, investors should reconsider before making investment decisions based on market patterns. Here are three things to keep in mind about the January effect and barometer.

1. While the average return in January has tended to be higher than the average return across the remaining 11 months, January was only the best-performing month 14 times in the past 96 years in US large cap, and eight times the past 45 years in US small cap.⁴ This means the January effect is only visible in the magnitude of returns in January compared to the other months of the year, not the frequency in which January outperforms them.
2. The accuracy of the January barometer is clouded by the fact that yearly stock market returns have been positive 2/3rds of the time, and January’s “predictive power” has really only gone one direction.⁵ After a gain in January,  full year returns have been positive 81% of the time. However, following a loss in January, full year returns have been negative just 54% of the time.⁶ This means when returns in January are negative, the January barometer is just slightly more accurate than a coin toss.
3. Exiting the market after a down January and missing a subsequent gain for the year could be detrimental to an investor’s long-run total return. Historical data shows that, over time, a buy and hold approach would have meaningfully outperformed a strategy that times the market based simply on the direction of January returns.⁷

Don’t lose sight of the long-term

The beginning of the year is often full of anticipation. By the end of the year, we usually find reality was different from our expectations. As in life – investors should not lose sight of the long term, regardless of what January brings.