January Barometer

One of a seasonal anomalies is the January Barometer. January barometer is a calendar anomaly which says that equity index returns from February to December could be forecasted by the January performance of the particular equity index. The theory says, that a strong January should predict strong performance of the whole year and vice versa. Although, following Januarys in which the market return was positive, the average market return over the following 11 months was significantly higher than the average market return over the 11 months following Januarys in which the market return was negative, this strategy should be taken with caution.

While the January Barometer should contain valuable information (however it may be just a data mining), the Barometer would have led an investor to be long the market during four of the five worst 11 month post-January intervals over the 152 years long backtesting period. Moreover, the simple long/short strategy of index would also lead the investor into disasterous short trades during bull markets. The aforementioned negative outcomes could be partially eliminated by the usage of long position in equity index combined with the bonds, but it is still questionable whether the strategy is rationally based, or is the product of upward trend of equities through the long time. However, according to the paper, the best usage of this barometer is the combination of equity index and treasury bonds. With a simple rule to long index after a strong January or to buy bonds after weak January. The aforementioned strategy should outperform passive long only strategy through the whole backtesting period, the long/short strategy according to Januarys and the long leg only of the January barometer strategy.

Fundamental reason

The fundamental reasons for the persistence of this anomaly in the future are very weak and any rational explanation cannot be found. However, the whole anomaly is probably only a consequence of data mining. Additionally, the spread between the market timing using January barometer and passive investment in the equity market is so small that it is probably not interesting (or wise) to pursue this strategy. On the other hand, there is a large ammount of research that does not support this strategy, for example Huang: "Real-Time Profitability of Published Anomalies: An Out-of-Sample Test": "The Other January Effect (OJE), which suggests positive (negative) equity market returns in January predict positive (negative) returns in the following 11 months of the year, does not outperform a buy-and-hold approach in the US equity market and therefore adds no value to market timers. There is also no evidence of the OJE working consistently on individual stocks or international markets." or the work of Marshall and Visaltanachoti, "The Other January Effect: Evidence Against Market Efficiency?": "The Other January Effect (OJE), which suggests positive (negative) equity market returns in January predict positive (negative) returns in the following 11 months of the year, underperforms a simple buy-and-hold strategy before and after risk-adjustment. Even the best modified OJE strategy, which benefits from several ex-post adjustments, does not generate statistically or economically significant excess returns."

Last but not least, Stivers, Sun and Sun in their work: "The Other January Effect: International, Style, and Subperiod Evidence" state that: "Our evidence indicates that the OJE is primarily a U.S. market-level-based phenomenon that has diminished over time, which suggests a `temporary anomaly' interpretation."Therefore, this strategy should be considered with a caution or maybe not traded at all, although the popular press tends to like it.

Markets traded
equities
Confidence in anomaly's validity
Weak
Notes to Confidence in anomaly's validity
Period of rebalancing
Monthly
Notes to Period of rebalancing
Number of traded instruments
1
Notes to Number of traded instruments
Complexity evaluation
Simple strategy
Notes to Complexity evaluation
Financial instruments
ETFs, funds, futures, CFDs
Backtest period from source paper
1857-2008
Indicative performance
10.38%
Notes to Indicative performance
per annum, return from table 3 (Long/T-bill strategy), benchmark return 9.98% (equity index)
Estimated volatility
16.80%
Notes to Estimated volatility
volatility from table 3 (Long/T-bill strategy), benchmark 19.2% (equity index)
Maximum drawdown
not stated
Notes to Maximum drawdown
Sharpe Ratio
0.38

Keywords:

seasonality, market timing

Simple trading strategy

Invest in equity market in each January. Stay invested in equity markets (via ETF, fund or futures) only if January return is positive otherwise switch investments to T-Bills.

Hedge for stocks during bear markets

No - Strategy is timing equity market but invests long-only into equity market factor therefore is not suitable as a hedge/diversification during market/economic crises.

Source Paper

Cooper, McConnell, Ovtchinnikov: What’s the Best Way to Trade Using the January Barometer?
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1436516
Abstract:
According to Streetlore, as embedded in the adage “As goes January so goes the rest of the year,” the market return in January provides useful information to would-be investors in that the January market return predicts the market return over the remainder of the year. This adage has become known as the January Barometer. In an earlier paper (Cooper, McConnell and Ovtchinnikov, 2006) we investigated the power of the January market return to predict returns for the next 11 months using 147 years of U.S. stock market returns. We found that, on average, the 11-month holding period return following positive Januarys was significantly higher, by a wide margin, than the 11-month holding period return following negative Januarys. In this paper we update that analysis through 2008 and address the question of how an investor can best use that information as part of an investment strategy. We find that the best way to use the January Barometer is not the obvious one of being long following positive Januarys and short following negative Januarys, but to be long following positive Januarys and invest in t-bills following negative Januarys. This strategy beats various alternatives, including a passive long-the-marketall-the-time strategy, by significant margins over the 152 years for which we have data.

Other Papers

Huang: Real-Time Profitability of Published Anomalies: An Out-of-Sample Test
http://www.nzfc.ac.nz/archives/2009/papers/20090112OJE.pdf
Abstract:
The Other January Effect (OJE), which suggests positive (negative) equity market returns in January predict positive (negative) returns in the following 11 months of the year, does not outperform a buy-and-hold approach in the US equity market and therefore adds no value to market timers. There is also no evidence of the OJE working consistently on individual stocks or international markets. The OJE requirement that the abnormally high January return be observed imposes a large opportunity cost. We highlight potential pitfalls of inferring the market timing ability of the OJE from the spread of 11-month returns following positive and negative Januaries.

Stivers, Sun, Sun: The Other January Effect: International, Style, and Subperiod Evidence
http://www.fma.org/Texas/Papers/lsun_janint_122007.pdf
Abstract:
We report international, style, and subperiod evidence for the Other January Effect (OJE) documented in Cooper et al. (2006). When examining the OJE in 22 countries starting as early as 1801, wefind that the spread between 11-month returns following positive and negative Januarys does tend to be positive. However, the spreads are rarely statistically significant and other calendar months' returns exhibit similar subsequent return spreads. Further, when first controlling for a country's OJE tied to the U.S. January return, there is essentially no incremental OJE relation tied to the own-country's January return. Next, for U.S. industry-level portfolios, we find that there is no incremental OJE spread tied to the own-industry January returns after first controlling for the market-level January returns. For U.S. size and book-to-market portfolios, the market-level January returns are also associated with larger spreads than the own-portfolio
January returns. Finally, for all the U.S. portfolios and for the major international markets, the OJE is appreciably weaker over the 1975 to 2006 post-discovery period than over the 1940 to 1974 pre-discovery period. Our evidence indicates that the OJE is primarily a U.S. market-level-based phenomenon that has diminished over time, which suggests a `temporary anomaly' interpretation.

Marshall, Visaltanachoti: The Other January Effect: Evidence Against Market Efficiency?
http://www.fullermoney.com/content/2010-03-02/Januaryeffrct.pdf
Abstract:
The Other January Effect (OJE), which suggests positive (negative) equity market returns in January predict positive (negative) returns in the following 11 months of the year, underperforms a simple buy-and-hold strategy before and after risk-adjustment. Even the best modified OJE strategy, which benefits from several ex-post adjustments, does not generate statistically or economically significant excess returns. When the OJE is tested with a method that is consistent with investor experience it is clear the OJE is no more profitable than an 11- month strategy that uses November or December as the conditioning month.

Hypothetical future performance

Real-time implementation by QuantConnect