Leading Economic Indicator

January was a great month for the stock market! The Dow Jones Industrial Average was up 2.7% and the S&P 500 Index was up 2.4%. It was the best January for the markets in 14 years.

Wow! Does that mean we’re going to have a Great Year? The “January Barometer” says so. But is this widely followed stock market indicator just another myth? The “January Barometer” works this way: If January is an “UP” month, it could mean a good year for the stock market. But if January is a “DOWN” month, well, that means that it would probably be a pretty dismal year for investors.

It would be nice if it worked, but unfortunately, the theory just does not hold up to scientific scrutiny.

So, what is the Truth? Well, economists refer to the stock market as a “leading economic indicator,” the direction of which is determined by the Wisdom of the Crowds. To put it another way, if in January, the millions of buyers and sellers out there believe that the markets and the economy will be better in, say 6 – 12 months, then stock market prices in January will rise. On the other hand, if the Wisdom of the Crowds believes that the markets will be lower in 6 – 12 months, then the stock market will drop accordingly for that month.

So clearly, in January, the masses of investors believed that things will be great – not now – but 6 -12 months from now. That’s the definition of a “leading economic indicator.” So what about February? Or March? Or the rest of the year? How will investors feel then about the prospects 6 -12 months further down the line? The answer is “Who knows?” To put it another way, the Markets are random in the short run.

Makes sense, doesn’t it? So, how should educated investors react? The answer is heavy diversification across all major asset classes, remain disciplined, avoid exuberance or pessimism, and to stay the course.