The stock market is full of adages and rules, but one carries a lot more weight than the rest: the January Barometer.
More than many of its peers, the saying that “as goes January, so goes the year,” tends to come true, to the tune of 84% of the time since 1945, according to S&P Capital IQ. Moreover, stocks tend to generate a healthy 11% rally during the 11 months following a green January.
Given last month’s 756-point surge on the Dow Industrials, their best first month performance since 1994, the January Barometer could lead Wall Street well beyond all-time highs in 2013. Savvy investors may also be able to use the early returns to position themselves to capitalize on this phenomenon.
“I have found no other month that works so well as a year-ahead indicator,” Sam Stovall, chief investment strategist at McGraw-Hill’s (MHP) S&P Capital IQ, wrote in a note on Monday. “Even though past performance is no guarantee of future results, I think this old saying will continue to offer sound indications in the year ahead, since it mirrors investor optimism.”
Of course, for the January Barometer to continue its strong track record, stock prices will have to overcome concerns about slow U.S. growth and looming battles over Washington’s spending and tax policies.
If the old adage holds true again this year, the S&P 500 would be poised to tack on 11.2% from last Thursday’s close, leaving the broad index at 1665.89. That’s an impressive 6.4% beyond the S&P 500’s all-time record high of 1565.15 that was set in October 2007.
For the Dow, which on Friday broke through the 14000 level for the first time in more than five years, an 11.2% rally would lift the benchmark to 15412.96, well above its record high of 14164.53 set in the weeks before the Great Recession began.
January was a particularly hot month for a number of big-name stocks, including top S&P 500 performers Netflix (NFLX), which surged a whopping 78% amid stellar earnings, and Best Buy (BBY), which leaped 37%.
So where is a believer in the January Barometer to invest?
Stovall recommends a very simple portfolio: buy and hold the 10 sub-industries of the S&P 500 that enjoyed the strongest returns last month.
According to S&P, since 1970 the 10 sub-industries in the S&P 500 that generated the best returns in January recorded a compound annual growth rate of 14.3% in the following 12 months, besting the overall index’s return by a near two-to-one margin.
While this portfolio held a higher standard deviation rate than the S&P 500, its return-for-risk ratio of 0.59 easily trumped the index’s 0.44, Stovall said. Moreover, this basket of stocks beat the S&P 500 an impressive 69% of the time.
Likewise, Stovall’s research reveals that the 10 sub-industries that suffered the worst January continued to stumble the rest of the year, posting a compound annual growth rate of just 4% in the following 12 months.
However, the January Barometer doesn’t always come true. While the top 10 sub-industries rallied 11.5% from January 31, 2012 to the end of last month, that trailed the S&P 500’s 15.3% return.
“Despite this recent setback, the long-term consistency of these sector and sub-industry [January Barometer Portfolios] remain encouraging, in my view,” Stovall said.
Led by a 22.6% surge for specialized consumer services, the best-performing S&P 500 sub-industries this January were: computer & electronics retail, health-care facilities, homebuilding, investment banking & brokerage, life sciences tools & services, office electronics, office services & supplies, oil & gas refining & marketing and trucking.
Since there aren’t many exchange-traded fund options, Stovall handpicked proxies for each sub-industry: H&R Block (HRB), GameStop (GME), United Health Services (UHS), NVR (NVR), Morgan Stanley (MS), Thermo Fisher Scientific (TMO), Xerox (XRX), Avery Dennison (AVY), Valero Energy (VLO) and Ryder (R).