Orlando's Outlook: Full-month 'January Barometer' flashing green
Bottom Line: Stocks bolted from the starting gate last month with their strongest January in 16 years, which has powerful implications for full-year equity market returns. The 5% rise in the S&P 500 marked the market’s best first-month performance since a 6.1% rally in January 1997. Not to be outdone, the blue-chip Dow Jones Industrial Average leapt by nearly 5.8% last month, while the small-cap Russell 2000 index surged by 6.2%. Since the S&P 500’s post-election correction last November, stocks have rallied by almost 13% to yesterday’s five-year high of 1,514.96.
While we continue to believe that the S&P 500 will break its all-time record high of 1,576.09 (achieved on Oct. 11, 2007) this year, we also remain concerned about fiscal policy dysfunction in Washington and the possibility of a random 3-5% air pocket. But the market’s early-year action suggests Washington-related investor concerns may be fading, so we’d use any temporary pullback as an opportunity to put some money to work. We are sticking to our full-year target of 1,660 for the S&P 500, which implies solid total-return potential of 15-20% for calendar 2013.
January Barometer—green light to go The “January Barometer” is one of the stock market’s most popular rules of thumb. Historically, as the first five trading days of January go, so goes the entire month, and as the month of January goes, so goes the full year. Since 1950, Jeffrey and Yale Hirsch at the Stock Trader’s Almanac report that 76% of the time (48 out of 63 instances), the direction of the entire year—up or down—was the same as that of the full month of January. Importantly, over the past 63 years, the S&P 500 started the new year with a positive month of January 39 times and finished the year higher in 35 of those instances for a 90% success rate.
How did January perform this year? For the full month, the S&P 500 enjoyed very strong nominal price appreciation of 5.04%, starting from 1,426.19 on Dec. 31, 2012 and ending at the closing price of 1,498.11 on Jan. 31, 2013. The total return over this period was a gain of 5.18%, substantially ahead of the S&P 500's median gain of 1.70% for the first month of each year for the past 63 years.
2013 is in excellent company Moreover, January's very strong 5.04% nominal return is the 12th-best first-month start to a new year over the past 63 years. Looking at those 11 better-performing years—in which first-month increases ranged from 5.1% to 13.2%—the full-year performance in each was positive every time, with an average full-year gain of 24.3%. In fact, if we dropped down and included the best 19 years (excluding 2013) in which January’s increases ranged from 4% to 13.2%, the full-year performance in each was positive in every instance, with an average full-year gain of 22%. So January 2013’s strong start augurs well by historical standards for the full year.
Post-presidential election year usually a downer Because 2012 was a presidential election year, 2013 is a post-election year. This typically would have poor historical performance implications for the stock market. Since 1950, eight of the 15 post-presidential election years (excluding the current one) started with negative Januaries; seven of those years went on to suffer negative full-year performance, and the average full-year return in all 15 post-presidential election years was only 4.43%. However, in the other seven post-election years that started with a positive January, full-year performance was positive six times—an 86% success rate. Full-year performance averaged a solid 15.84% for all seven positive-January years and 20.65% in the six years that also experienced positive full-year returns.
Fundamentals still matter With roughly 75% of the fourth-quarter 2012 earnings season now complete, year-over-year revenues are up about 3%, a positive 0.6% surprise over consensus expectations, with about half of the companies beating expectations. Year-over-year earnings are up about 6%, representing a positive 5% surprise over consensus expectations, with about 70% of the companies beating expectations. So S&P 500 earnings for 2012 will probably finish up at about $101 per share (versus $98 in 2011), with consensus top-down earnings estimated at $108 for 2013, which translates into a current Price/Earnings (P/E) ratio of 14 times. Although P/E multiples have expanded from 11 to 14 times over the past four years, that remains undervalued in our view, with yields on benchmark 10-year Treasuries flirting with 2% and the core year-over-year Personal Consumption Expenditure (PCE) inflation index shrinking to a very benign 1.4% in December. We expect P/Es will grind higher over the next several years, perhaps to 17-18, greased in part by the massive disintermediation that may be underway as investors in recent months have begun to shift from bonds into stocks.
What are the best sectors and industries? So, then, where to invest? The “January Barometer Portfolio” indicator also suggests that the best- and worst-performing S&P 500 sectors and industries in January tend to follow that performance trend through the balance of the calendar year. Here are the S&P 500’s 10 sectors, sorted by their total-return performance in January 2013. (We actually list 12, but that’s because of Apple’s outsized impact on the information technology sector. With Apple, which plunged by 14.6% last month, IT doesn’t crack the top 10; without Apple, IT does. So we opted to represent IT both with and without Apple.):
- Energy, 7.6%
- Health care, 7.5%
- Financials, 6%
- Consumer staples, 5.8%
- Consumer discretionary, 5.7%
- Industrials, 5.6%
- Information technology (excluding Apple), 5.5%
- S&P 500, 5.18%
- Utilities, 4.9%
- Materials, 3.9%
- Telecommunication services, 3.2%
- Information technology (including Apple), 1.4%
Here are the actual total returns for the 10 best out of the 24 S&P 500 industry groups for January 2013, all of which outperformed the S&P 500’s total return of 5.18%:
- Household & personal products, 9.2%
- Transportation, 8.0%
- Insurance, 7.9%
- Pharmaceuticals & biotech, 7.8%
- Energy, 7.6%
- Retailing, 6.9%
- Health care equipment & services, 6.8%
- Commercial services & supplies, 6.7%
- Diversified Financials, 6.7%
- Tech hardware & equipment (ex-Apple), 6.3%
In contrast, here are the nine worst-performing S&P 500 industry groups for January 2013, the last of which has a negative total return because it includes Apple:
- Consumer Durables & Apparel, 4.4%
- Food & Staples Retailing, 4.3%
- Banks, 4.1%
- Semiconductors, 4.0%
- Materials, 3.9%
- Telecom Services, 3.2%
- Real estate, 2.9%
- Autos & components, 1.8%
- Tech hardware & equipment (with Apple), -4.7%