Good January, good year?
The S&P 500 started off the year with a bang. That could be a harbinger of good things for stocks in 2006.
NEW YORK (CNNMoney.com) - Stocks may have had a tough day Thursday, but if the well-known January barometer is correct, it still ought to be a good year.
As made famous by the Stock Trader's Almanac, the January barometer essentially says that the performance of the S&P 500 in January is usually indicative of the market's performance for the rest of the year.
And this January was a positive one, with the S&P 500 rising 2.5 percent. That's good news for the rest of the year, right?
"I don't believe in these kinds of indicators, but I do believe in momentum," said Ned Riley, chief investment officer at Riley Asset Management. "The momentum in January was good and I do think we will have an up year, but not because of an indicator."
Timothy Ghriskey, chief investment officer at Solaris Asset Management, was less bullish, saying that the gains in early January were likely a result of investors buying back stocks after selling them at the end of 2005, as is typical at the start of the year.
"I would not extrapolate that 2.5 percent monthly gain in January into the rest of the year," Ghriskey added.
Granted, betting on quirky market indicators can be dangerous, as any investor who has tied his or her fortune to the Super Bowl indicator, the hemline indicator or the dreaded Shaq curse can tell you.
But insofar as indicators go, the January barometer is among the most respectable.
Since 1950, the barometer has proven correct 91 percent of the time, according to the Almanac, or 80 percent of the time, when you factor out years that ended essentially flat.
The barometer tends to be less accurate in years when January is a down month, like 2005.
Since 1950, when the S&P 500 fell in January, the index also closed lower for the year less than half the time, or 10 out of 21 years. A recent example is 2005, when the S&P 500 lost 2.5 percent in January but finished the year 2.5 percent higher.
But in up years, the stats are much better. Since 1950, there have been 35 up Januarys for the S&P 500, and in all but three years, the index closed higher for the year as well.
Why does this indicator work so well?
For one thing, a strong January gives the market a built-in "cushion" for the rest of the year.
For another, the month often brings news that influences how investors see the year shaping up. Congress convenes. The president gives the State of the Union address, introduces the year's budget and prioritizes the agenda for the year ahead.
But it's also an issue of how investors feel, said Sam Stovall, chief investment strategist at Standard & Poor's. "I think investors are a lot like dieters," Stovall said. "They look at January as a good month to start anew."
He says investors typically reposition their portfolios in the month based on what they expect will perform well for the year and then make few major changes beyond that point.
Stovall tracks what he calls the January Barometer Portfolio (JBP), in which he tracks a "frozen portfolio" of the 10 best-performing S&P industries in the month of January during the next 12 months.
Since 1970, the JBP has outperformed the S&P 500 over that period 75 percent of the time, with a compound annual growth rate of 17.3 percent, versus 7.8 percent for the S&P 500 overall, excluding dividends.
Will it work this year?
"I would say that given its accuracy historically, given that technical indicators I look at are strong and the likelihood that market fundamentals will remain positive in 2006, it's hard to argue against it this year," said Steven Goldman, market strategist at Weeden & Co.
Additionally, noted S&P's Stovall, a strong 2006 would confirm another historical trend that says the fourth year of bull markets tend to be strong, as healthy economic conditions allow bulls to catch a second wind.
Still, most market experts said any gains for the full year will probably be modest, with the S&P 500 likely to rise in the single digits, like it did last year.
Also like last year, the market could potentially see-saw through the summer and then rise in the fourth quarter, a typical pattern on Wall Street.
But there are factors that could cause the market to stall out this year, like slower earnings growth, the impact of sustained higher oil prices, a possible pickup in inflation and higher interest rates.
The latest surge in oil prices, as well as signs that wage growth may be set to accelerate, could translate into higher inflation that causes the Federal Reserve to extend its rate-hiking campaign. The central bank raised rates for the 14th straight time Tuesday in Alan Greenspan's last meeting as chairman. (Full story).
Beware the second year
There's also a good chance that stocks could suffer a steep selloff, hitting a so-called market bottom, in the second half of 2006, before rallying near the end of the year, analysts say.
That's because 2006 is the second year of the presidency, which can be very tricky, according to the Almanac. This comes from another respectable theory -- that the stock market follows the four-year cycle of the presidency.
"I think there's going to be a great buying opportunity, but first there's going to be pain," said Harry Clark, chief executive of Clark Capital Management Group. Clark cited the market bottom in October 2002, which then led to a stellar 2003 as a good example.
But there doesn't have to be a big selloff before there is an advance this year, Weeden's Goldman said.
"At this point in an economic cycle, you would typically see long-term interest rates jump, but that hasn't happened," he added. "One would think if we were going to have a tough year, we would have started things off with less resilience. But that wasn't the case."
Was the market's fast start too much too soon this year? Full story.
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