As Goes January, So Goes the Year in Stocks?

January is bellwether time for the stock market. A strong start for stocks often bodes well for the months that follow.

Historically, the first few trading days of January have been among the strongest for stock performance, because this is when individuals and pension plans add big chunks of new money to retirement accounts. Whether people follow their normal pattern and pump money into stocks in January can be a sign of the market's prospects for the coming weeks, and even for the entire year.

If stocks rise in January, they often finish the year strongly. If stocks are weak during this normally propitious time, stocks tend to do poorly.

January was weak in both 2008 and 2009. In 2008, the Dow Jones Industrial Average fell another 30% in the following 11 months, marking one of the worst stock-market years on record. In 2009, the January decline was followed by an 18% plunge to a 12-year low in March. Only after that pain did stocks roar back.

This time, stocks already have gotten off to a disappointing start.

In normal years, investors try to front-run the expected January rise, and they bid stocks higher in late December. Since 1900, the Dow has risen a median 1% in the last five trading days of December, according to Ned Davis Research, more than four times the median rise for five-day periods in general. In the five final trading days of this December, however, the Dow actually fell 0.37%.

Now, investors are worrying about whether the December weakness will carry through into January. If so, it could augur poorly for 2010, or at least for the first months.

"Strong years for equities normally show investment-buying early, with great upside momentum in January; most bad years start with down Januarys," notes Phil Roth, chief technical market analyst at New York brokerage house Miller Tabak + Co., in a report on January's importance.

What analysts would like to see now is a strong January rally on heavy volume, suggesting investors are pouring new money into U.S. stocks. During much of the Dow's big post-March rally, trading volume has been below-average, suggesting that many investors remain skeptical of U.S. stocks. If volume remains low in January, it would be a further indication of investor doubt.

"I don't think we are going to see the best of Januarys, but perhaps better than we have seen" in recent years, says Bruce McCain, who helps oversee $22 billion as chief investment strategist at Cleveland's Key Private Bank. Ordinary investors remain nervous about stock prospects and may not buy as much as in a normal January, he says.

Data support the idea that this period is a bellwether. Since 1900, the Dow's median rise for the first five trading days of January is 0.63%, almost triple the median increase for ordinary five-day periods, according to Ned Davis Research.

The data also suggest that performance for the full month of January can be linked to what follows.

In years when the Dow has risen in the first month of the year, the median rise for the rest of the year is 10.4%. In years when the Dow has fallen, the median rise for the next 11 months is just 0.28%.

Because of the inflows of new cash, January has seen stock advances 62% of the time since 1900, well above the average of 57% for all months.

In fact, November, December and January typically are the market's strongest three-month stretch, as investors position themselves for the new year. Early December often is soft, possibly because tax-conscious investors are selling losing stocks to generate tax losses that they can balance against taxable gains in other stocks. If things are on a normal footing, that weakness should be over by late December, and stocks should be rising ahead of a strong January.

Analysts still have plenty of doubts about how much more U.S. stocks will benefit.

Investor optimism seems to be rising now, so there could be strong flows of new money into financial markets in January, says Edgar Peters, an investment strategist who helps oversee $15 billion at First Quadrant in Pasadena, Calif.

"The question is where new investment money will go this time," Mr. Peters says. In the post-February rally, investors tended to put new money into bonds and into emerging markets, such as India and China, rather than into U.S. stocks.

Starting in March, investors have removed a net $22.65 billion from U.S.-stock mutual funds, while adding a net $34.27 billion to foreign-stock funds and $315.54 billion to bond funds.

"It is more likely that we will see further flows into emerging markets, since those are the best-performing right now," Mr. Peters says.

Some market analysts worry that stocks could perform moderately well in January, but that problems could show up later in the year, as central banks try to mop up some of the hundreds of billions of dollars they pumped into the financial system.

"The tailwinds that have been in place are likely to continue into the first half of 2010," says Jeffrey Kleintop, chief market strategist at brokerage house LPL Financial in Boston. "Those tailwinds fade as the Federal Reserve discontinues its programs, including programs to buy mortgage-backed bonds. And it isn't just the Fed: It could be the first time in history that almost every central bank in the world is constraining monetary policy."

Mr. McCain of Key Private Bank is warning clients to beware of market trouble later in the year.

What is more, corporate-profit expectations will be rising as the year progresses, and it could become harder for companies to keep meeting those expectations, says Russ Koesterich, head of investment strategy at Barclays Global Investors in San Francisco.

He also worries that government borrowing to cover mounting deficits eventually could push up interest rates, hurting both bonds and stocks.

from Wall Street Journal