Orlando's Outlook: Positive 'January Barometer' raises likelihood of good year

02-08-2017

Bottom Line For the first time in four years, the S&P 500 enjoyed a positive January, rising a slightly-above-average 1.79% for the full month on a price-only basis, as investors continued their post-election enthusiasm. That’s good news, according to the historical track record of the January Barometer, a theory which holds that since 1950, a positive first month translates into a positive full year 90% of the time. To be sure, fundamentals still matter most, and we’ll spend the next 11 months diligently analyzing President Trump’s fiscal-policy initiatives and their likely impact on the economy and the financial markets. But it’s certainly a lot more comfortable bolting from the starting gate in good shape this year, and playing with the house’s money for a change.

Positive January Barometer reading The January Barometer remains one of the stock market’s most popular rules of thumb: Historically, as the first five trading days of January go, so goes the month; and as the month goes, so goes the year. Jeffrey and Yale Hirsch of the Stock Trader’s Almanac report that 75% of the time (50 out of 67 instances) since 1950, the direction of the entire year (up or down) was the same as that of January. But when the S&P started the new year with a positive January, as it has done 40 times since 1950, it finished the year higher 36 times—a success rate of 90%.

How did we perform in January 2017? For the full month of January 2017, the S&P enjoyed a slightly-above-average nominal price increase of 1.79%, starting from 2,238.83 on Dec. 30, 2016, and ending at the closing price of 2,278.87 on Jan. 31, 2017. The total return (which includes dividends) was 1.90%. This performance leads the mean and median nominal gains of 0.94% and 1.6%, respectively, which the S&P has enjoyed in January of each of the past 67 years.

This January bodes well for full-year performance There have been 31 instances in which the S&P in January performed equal to or better than this year’s 1.79% nominal return, and the subsequent full-year return was negative only three times, with an average full-year return of 18.8%. But if we examine returns more closely surrounding the portion of the performance spectrum where this recent January 2017 fell—a relatively tight 1-month performance range of 1.4% to 2.3%, with only seven observations—subsequent full-year returns averaged a still-healthy 12.6%.

Not a straight line up Recall that from the intraday trough of the S&P on election night—when investors stunned by Trump’s win quickly dumped stocks by 5% to 2,028.50—stocks rallied hard by 10% into year-end, as investors began to discount a more market-friendly set of fiscal policies under a Trump administration and consolidated Republican Congress. They followed that powerful rally by tacking on another nominal gain of 1.34% during the first five trading days of 2017, and continued to grind stocks higher to a 1.79% full-month gain for January.

But there’s also an historical tendency in the first year of a new administration to experience some modest consolidation—perhaps 2-4%—over February and March, before stocks resume their gradual ascent. To be sure, we are not abandoning our bullish long-term forecast that the S&P will hit 2,350 on estimated 2017 earnings of $130 and 2,500 on 2018 earnings of $140. We’re merely suggesting that stocks could hit a modest air pocket near term, which would provide us with an attractive entry point to add to existing equity positions.

Equity markets hate uncertainty There’s also little question that the Trump administration is the poster child for uncertainty and potential volatility, so there are several key fundamental developments we’ll be watching closely over the course of 2017 to glean their possible impact on economic and corporate-profit growth and, ultimately, on financial-market performance:

  • The timing of tax-reform legislation, how sharply rates are cut and whether the changes are retroactive to the beginning of calendar 2017.
  • The pace of interest-rate hikes by the Federal Reserve, and who might replace Janet Yellen as chair when her term expires in a year.
  • The risk of trade wars, protectionism, tariffs and border-adjusted taxes.
  • Geopolitical risks, such as Brexit and elections in Germany, France and Italy.
  • Rising energy prices potentially crowding out domestic consumption.
  • U.S. dollar strength impairing American exports. 

What are the best sectors and industries to own in 2017? The January Barometer Portfolio Indicator also holds that, historically, the best- and worst-performing S&P sectors and industries in January tend to follow that performance trend throughout the rest of the calendar year.

Here are the S&P’s 11 sectors, sorted by their total-return performance in January 2017. There is more of a cyclical bias among the better-performing categories, and less reliance on defensive, dividend-oriented sectors, as we saw in the first half of 2016:

  • Materials, 4.6%
  • Information Technology, 4.4%
  • Consumer Discretionary, 4.2%
  • Health Care, 2.2%
  • S&P 500, 1.9%
  • Consumer Staples, 1.6%
  • Industrials, 1.4%
  • Utilities, 1.3%
  • Financials, 0.2%
  • REIT’s, -0.1%
  • Telecommunication Services, -2.5%
  • Energy, -3.6%

Drilling down further, here are the actual total returns for the six best industries out of the S&P’s 24 industry groups for January 2017. These are the top-quartile performers, all of which easily outperformed the S&P’s total return of 1.9%: 

  • Media, 7.2%
  • Technology Software and Services, 5.3%
  • Health Care Equipment and Services, 4.8%
  • Materials, 4.6%
  • Technology Hardware and Equipment, 4.2%
  • Household and Personal Products, 4%

 In contrast, here are the six worst-performing S&P industry groups for January 2017—the bottom-quartile performers—several of which are defensive dividend payers: 

  • Banks, 0.1%
  • REIT’s, -0.1%
  • Consumer Services and Supplies, -0.6%
  • Food and Staples Retailing, -1%
  • Telecommunication Services, -2.5%
  • Energy, -3.6%