January Barometer Broken, But That’s Probably A Good Thing by John Dorfman, Dorfman Value Investments

Winter storms have been raging, not only in the weather, but in the stock market. So, naturally, all eyes are on the barometer.

The January barometer in the stock market is the theory that “as January goes, so goes the year.” Since the first two weeks of January were the worst on record, that is a frightening thought.

However, investors may take some consolation from the fact that the January barometer theory is flawed. Here are the five worst Januarys on record before this year, and the stock-market performance for the full year, measured by the Standard & Poor’s 500 Index.

  • 2009 — January performance: -8.6 percent; full-year performance: +26.46 percent
  • 1970 — January performance: -7.6 percent; full-year performance: +4.01 percent
  • 1960 — January performance: -7.1 percent; full-year performance: +0.47 percent
  • 1990 — January performance: -6.9 percent; full-year performance: -3.17 percent
  • 1978 — January performance: -6.2 percent; full-year performance: +6.56 percent

As you can see, four of the five years containing terrible Januarys ended up as profitable years in the market.

Naive models

The barometer concept was popularized by Yale Hirsch, the longtime editor of Stock Trader’s Almanac, and more recently by his son and successor Jeffrey. The Hirsch family likes to exclude relatively flat years when they calculate the barometer’s success rate. I prefer to count all years. Counting my way, the barometer has been correct in 38 of the past 54 years for a success rate of 70 percent.

Since January is part of the year being predicted, a more interesting test is whether January predicts the next 11 months. On that basis, the January barometer has been right in 36 cases out of 54, for a success rate of 66.6 percent.

That doesn’t sound too bad. But any forecasting tool should be judged against a naïve model. If you’re predicting the weather, one test could be how accurate you are compared to a simplistic model that predicts every day will be the same as the day before. If you’re predicting the stock market, one test would be how you do versus a model that assumes every year will be up.

The naïve “Up Every Year” model has been right 40 times out of the past 54 years, a 74 percent success rate.

One thing I will concede regarding the barometer model: Rarely is the full year down without January being down. The last 10 down years were 2008, 2002, 2001, 2000, 1990, 1981, 1977, 1974, 1973 and 1969. January was a down month in nine of those 10 years.

However, the barometer gave false warnings in many years, most recently including 2009, 2010, 2014 and 2015.

So what’s my prediction for 2016? I think it is likely to end up as a moderate up year, despite a 9 percent loss in the first 13 trading days. Why? I believe the U.S. economic recovery is intact and will not be wrecked by economic weakness in China or Europe. Unemployment is improving, inflation is low, auto sales set a record in 2015, and housing is slowly coming back.

The presidential election will stir the pot of uncertainty for most of the year, but that uncertainty will be resolved in early November. Election years often see strong stock-market performance in the final two months.

Bounce-back candidates

Here are a few stocks that have been smacked down in this year’s January sell-off and that I think are now selling below their intrinsic value.

Norfolk Southern Corp. (NSC), down 19 percent this year through January 22, is the fourth-largest U.S. railroad by revenue. It is unpopular with investors because it carries a lot of coal, and the use of coal is discouraged by environmental regulations and by the availability of cheap oil and gas. But this railroad has been profitable for 19 consecutive years and is being pursued by Canadian Pacific as a merger candidate. So far, Norfolk Southern has said no.

Raymond James Financial Inc. (RJF), down 22 percent for the same period, is a large brokerage house with substantial money management operations. (notably Eagle Asset Management). I think its securities research is above average, and I am impressed that the company has stayed consistently profitable in a notoriously cyclical industry. The stock sells for 14 times recent earnings and 11 times this year’s estimated earnings.

I also like a smaller stock, Fresh Market Inc. (TFM), which was down about 20 percent. There are signs of slowing in the organic and healthy foods segment, but I believe the underlying trend is still up. At 15 times earnings and 0.5 times revenue, Fresh Market seems attractive to me. I also think it has takeover potential: At a market value of $882 million, it is bite-sized.

January Barometer Broken, But That's Probably A Good Thing

January Barometer