What stock-market investors need to know about the ‘January Indicator Trifecta’

See: Here are five stock-market ‘early indicators’ that could decide the fate of your portfolio in 2023

Santa’s late gift 

At the end of the second trading day of a new year, stock-market investors usually tally up what’s known as the “Santa Claus rally”, which refers to the stock market’s tendency rise in the last five trading sessions of the year, plus the first two sessions of the new year.

A failure to rally during the period is seen as a sign that further selling is likely in store.

This year, though Kriss Kringle did make a stop at Wall Street, he did not reward investors with anything big to start the year. The S&P 500 gained merely 0.8% during the most recent Santa rally period that concluded Wednesday, versus a long-term average of 1.3%. The Dow Jones Industrial Average advanced 0.7% but the Nasdaq Composite dropped 0.2%, according to Dow Jones Market Data.

“It was a choppy ride this time around, but the S&P 500 found some footing Wednesday… Including this year, Santa has paid Wall Street a visit 59 times since 1950,” wrote Jeff Hirsch, editor-in-chief of the Stock Trader’s Almanac and Almanac Investor, in a Wednesday note. 

U.S. stock indexes finished higher on Wednesday, snapping a two-day losing streak as investors assessed Federal Reserve meeting minutes that showed none of the policymakers expect any interest rate cuts in 2023, as they awaited more evidence that inflation was on a sustained downward path.

January’s first 5 days

A late but positive Santa Claus rally is encouraging for stock-market investors, but they will be looking for more clarity when January’s “First Five Days Early Warning System” gives its reading later this week and when the “January Barometer” reports at the end of this month. 

According to Stock Trader’s Almanac, the first five trading days of January could predict the market’s direction for the year. The last 47 up First Five Days were followed by full-year gains for an 83% accuracy ratio and a 14% average gain in all 47 years. 

The S&P 500 and the Dow industrials each gained 0.4% in the first two trading days of 2023, while the Nasdaq Composite shed 0.1%, according to Dow Jones Market Data.

‘As goes January, so goes the year?’ 

There’s an old saying on Wall Street that “as goes January, so goes the year,” otherwise known as the “January Barometer.” Supporters of this view believe that if the S&P 500 rises between Jan. 1 and Jan. 31, this will foretell positive returns for the remainder of the year. Similarly, it holds that if the market fares poorly in January, it will likely perform poorly this year. 

Eric Diton, president and managing director at The Wealth Alliance, told MarketWatch that while the Santa Claus rally doesn’t dictate direction to the market after that, the “January Barometer” is “by no means a guarantee, but it has been a decent indicator.”  

Stock Trader’s Almanac’s data shows that the barometer only registered 12 errors since 1950 for an 83.3% accuracy ratio.

DataTrek co-founder Nicholas Colas thinks this January may see a lift after “an unusually bad December” likely due at least in part to tax loss harvesting, a practice which involves selling stocks at a loss to use that loss to offset taxes owed on investment gains. 

A bad December 2022, which saw the S&P 500 down 5.9%, should set up domestic equities for a rally in January, since this selling pressure is now gone, wrote Colas in a Wednesday note. 

However, a rally in the first month of 2023 does not necessarily guarantee a positive return over the next 11 months. U.S. equities enter 2023 with a mechanical tailwind in the form of no more tax loss selling, but still suffer from headwinds related to Fed policy and uncertainty over corporate earnings uncertainty, he said.

“We would not be surprised to see U.S. equities begin 2023 on an up note…but caution that ‘so goes January, so goes the year’ may not tell us much about the cadence of returns over the next 12 months,” Colas said.

MarketWatch’s Mark Hulbert has cautioned against reading much into the barometer and other January indicators and what they say about the subsequent 11 months, saying their long-term record doesn’t demonstrate a statistically significant signal.

Is a ‘January Effect’ in the cards?

The “January Barometer” is not to be confused with the “January Effect”, which is a seasonal tendency for small-cap stocks to rally during the month following December’s tax loss harvesting in those generally illiquid equities. Theoretically, investors could use those funds to rebuy new positions in January, which contributes to the monthly rally. 

Strategists at Jefferies see a strong possibility for a January Effect this year, given the fact that when a majority of stocks are in the red for the year, the next January’s return will be above average with lower market cap performing the best.

“If ‘January Effect’ happens in January, it boosts our smaller is better thesis,” said equity strategists led by Steven G. DeSanctis, in a December note. “We think this will not be restricted to just one month of better performance, as these stocks are the cheapest part of the equity market, bounce the most coming out of Bear markets, M&A is running above its long-term average for names less than $1 billion. We are only waiting for flows to pick up, which we think will happen as the calendar turns.”

See: Stock market acting like it did before the recession of 1969, JPMorgan strategist finds

U.S. stock indexes were sharply lower on Thursday after jobs data showed the labor market is still strong. That’s likely to be unwelcome news for a Federal Reserve worried a tight labor market might fuel high inflation. The S&P 500 dropped 1.1%, while the Dow industrials declined by 1.2% and Nasdaq Composite was off 1.3%.