In case you hadn't noticed amid all the recent stock market craziness, the S&P 500 finished January down 1%. Some market-watchers say that doesn't bode well for the rest of 2021.
There's an old-school investing rule behind their concern: "As goes January, so goes the year." The so-called January barometer posits that the stock market tends to go up for the rest of the year following a prosperous January and tends to struggle after a disappointing one.
If you study investing long enough, you're bound to hear about a variety of such stock market indicators. Some can be dismissed out of hand. Just because the S&P 500 tends to perform better after an NFC team wins the Super Bowl doesn't mean you should be pulling for the Bucs on Sunday, for example. And you there's no point eyeing trends at Paris Fashion Week on the theory that shorter skirt styles are an indicator of continuing economic prosperity.
But other market truisms have a stronger statistical backing. The old investing aphorism "sell in May and go away" has roots in behavioral economics and is backed up by the numbers: Stock market returns tend to be higher between November and April and more muted from May through October.
As with the "sell in May" saying, there are some statistical arguments to be made for the January barometer's validity.
Video by Helen Zhao
A look at the historical record of the January barometer paints a potentially troubling picture for stocks in 2021. Since 1950, the S&P 500 has returned 11.9% on average in the 11 months following a January in the green, and has been higher 86% of the time. Following a negative January, stocks were positive just over 60% of the time and posted an average return of just 1.7%.
So should investors be concerned? Maybe, says Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Securities. She cites the weak January as one of many similarities between today's market and the tech-bubble-driven market of 2000. Other commonalities include widespread investor euphoria, steep stock market valuations, and a large number of stocks gaining no traction among investors despite posting better-than-expected earnings.
If the average price-to-earnings ratio among stocks snapped back to normal, "all else equal, we could see close to 10% downside to stocks," she wrote in a recent note.
None of that means you should sell your stock portfolio because indexes flinched in January. For one thing, while the historical numbers are compelling, recent history has been kinder to stocks after a tough first month.
"The good news is lately the trend has been broken, as stocks have done quite well after a weak January," wrote Ryan Detrick, chief market strategist for LPL financial, on the investing research firm's blog. In fact, stocks rose during the final 11 months in 8 of the past 9 times the S&P 500 has posted a negative January return, for an average 11.5% gain.
If you think the market is likely to be choppy, or even experience a steep decline this year, you still likely shouldn't make wholesale changes to your portfolio, says Kristina Hooper, chief global market strategist at Invesco. "Investors aren't good at market timing," she says. "I can point to the global financial crisis as a perfect example. The investors that were hurt most weren't the ones that were invested in stocks throughout. The ones that were hurt most got out while stocks were falling and never got back in."
Rather than making changes in anticipation of a potential pullback, Hooper suggests preparing for a buying opportunity. "You don't need to be concerned about market tops unless you have a very short time horizon," she says. "If I'm a long-term investor, I'd increase my cash allocation so I could pick up stocks at bargain prices once they fell."
More from Grow: