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As first discovered and reported long ago by Yale Hirsch, the founder of the Hirsch Organization and the original editor of the venerable Stock Trader's Almanac, the performance of the stock market during the month of January typically has a fairly direct correlation to the action of the market during the ensuing eleven months. In my most recent book, "Seasonal Stock Market Trends." I wrote about something I dubbed "The JayNewary Barometer," which is simply a slightly tweaked version of Hirsch's original January Barometer (Hey, I only steal, er, "borrow," from the very best).

The Three Measures of January

There are three measures of January market performance that make up the JayNewary Barometer. For each I use the Dow Jones Industrials Average.

1. If the first five trading days of January register a net gain, add 1 point to the model.
2. If the last five trading days of January register a net gain, add 1 point to the model.
3. If the month of January as a whole registers a net gain, add 1 point to the model.

After the close on the last trading day of January, the JayNewary Barometer will necessarily stand at a reading of 0, +1, +2 or +3. The subsequent action of the stock market during the remaining eleven months of each year appears in Figure 1.

Figure 1 - January 31st through December 31st Dow performance following various JayNewary Barometer readings

As you can see in Figure 1, readings of "0" have typically been followed by more "pain" during the rest of the year. Readings of +1 have been essentially meaningless. Readings of +2 or +3 have historically been a very positive sign for the stock market. In fact, 91% of all years since 1934 during which the JayNewary Barometer has registered a reading of +2 or more have seen the Dow rise even further by the end of the following December. The average gain following readings of +2 is 10.5% and +13.3% following readings of +3. For a method that requires almost no work and no subjective interpretation, these are very impressive results.

Still, there are a few caveats of which investors should remain aware.

A Few Caveats

Investors should remember that "January indicators" are just that, indicators. They

"suggest" a likely direction. So let's be clear: no one should rely solely on January indicators to tell them whether to be in the market or not. The proper use (in my opinion) is to give the bullish case the benefit of the doubt if the JayNewary Barometer is bullish and to give the bearish case the benefit of the doubt of the JayNewary is bearish.

The year 2009 was a good case in point regarding these caveats. The first five days, the last five days and the month of January as a whole each showed a loss. As a result, the JayNewary Barometer registered a bearish reading of "0." During 6 of 7 previous such readings, the Dow declined between the end of January and the end of the year. In 2009 it first looked like another accurate call was in the making as the Dow fell hard from the end of January into the early part of March. From there, however, the market rallied hard and closed the year sharply higher from its January close. On the other hand, in 2008, the JayNewary Barometer reading of "0" was extremely fortuitous as the Dow plunged over 30% between the end of January 2008 and the end of December 2008.

On the bullish side, clearly the odds have favored a bullish continuation following previous readings of +2 or +3. Nevertheless, it should be noted that a bullish JB reading in no way immunizes investors from risk. In 1966 the stock market fell hard despite a bullish JB reading and someone blindly following the JB would have ridden out the 1987 October bear market crash.

So again, simply remember this: if the JayNewary Barometer gives a bearish reading of "0" and the market is acting poorly, investors should consider pressing the short side of the market. Likewise, if the JayNewary Barometer registers a reading of +2 or +3 and the market is acting well, investors should play the long side of the market aggressively.

So What About 2010?

The good news is that a reading of at least +2 appears to be in the works as long as the Dow hold above the December 31st close of 10,428.05 (roughly 300 points lower from present levels). If the last five trading days of January show a net gain then the most bullish reading of +3 will be in force. Figure 2 displays the growth of $1,000 invested in the Dow only between February and December of those years when the JayNewary Barometer registered a reading of +2 or +3.

Figure 2 - Growth of $1,000 invested in Dow only during Feb. through Dec. of those years with a JayNewary Barometer reading of +2 or +3 (1934-2009 with 1% annualized interest earned while out of market)

Figure 3 displays the same chart as in Figure 2 along with the growth of $1,000 invested in the Dow on a buy-and-hold basis.

Figure 3 - Growth of $1,000 invested in Dow only during Feb. through Dec. of those years with a JayNewary Barometer reading of +2 or +3 (1934-2009 with 1% annualized interest earned while out of market) versus buy-and-hold (red line)

SUMMARY

So let's sum up the good news and the bad news. The good news is that a compilation of January indicators have done a pretty good job historically of telling investors which side of the market to be on the bulk of the time. In fact, being in the market only when the JayNewary Barometer is at +2 or more outperformed a buy-and-hold approach over the previous 76 years with less downside volatility. The bad news is that what will happen in the future may or may not follow the trend of what has happened in the past. As such, investors should pay attention to how the Dow closes out the month of January, and should resolve to be aggressive on the bullish side of a reading of +2 or 3 is achieved. Nevertheless, if the market breaks investors should not "hang on" clinging to the belief that some particular indicator will rescue them in the end.

Jay Kaeppel
Staff Writer and Author of Seasonal Stock Market Trends
Optionetics.com ~ Your Options Education Site

Questions for Jay? Please visit "Ask the Traders" through the discussion board on the Optionetics.com home page.

NOTE:

Jay's latest book, Seasonal Stock Market Trends: The Definitive Guide to Calendar-Based Stock Market Investing, was ranked among the Top 10 Investment Books for 2009 by the venerable The Stock Trader's Almanac 2010. For more info, please click here.

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