The stock market started off 2015 badly, reflecting investors' worries about everything from plunging energy prices and rising geopolitical tensions to the strong U.S. dollar and weak macroeconomic conditions across most of the world. During the month of January, the Dow Jones Industrials (DJINDICES:^DJI) fell more than 650 points, or 3.7%, while the S&P 500 (SNPINDEX:^GSPC) and Russell 2000 (RUSSELLINDICES:^RUT) suffered similar declines of between 3% and 4%. The dour performance has many market participants thinking that January might merely be a sign of worse things to come for the stock market throughout 2015. Yet even though the market is long overdue for a substantial correction, investors shouldn't count out the potential for an overall positive performance this year just yet.
As goes January, so goes the year?
One common view among professional investors is that the direction of the market in January foretells how strong or weak the entire year will be. When people are hungry to buy stocks early in the year, increased demand often builds on itself as investors respond to the resulting positive returns that the market produces. By contrast, when stocks fall early in the year, it makes some investors skittish, making them more reluctant to invest and creating a negative feedback loop that can itself spur a further pullback.
However, as with many seasonal indicators, the track record of this version of the so-called "January Effect" is spurious. Last year, for instance, stocks fell in January, yet 2014 was a solid year for the stock market, with the S&P 500 notching total returns of about 14% on a total-return basis for the S&P 500 and the Dow Jones Industrials gaining about 7.5%. Similarly, poor performance early in 2009 and 2010 gave way to double-digit percentage gains by the time the year ended.
Admittedly, there are several worrying factors that investors have to consider right now. The Federal Reserve is considering how to finally start returning the U.S. economy to a self-sustainable track, having withdrawn its quantitative easing stimulus, and it's now seeking a prudent way to return short-term interest rates to more typical levels. The strong U.S. dollar has punished financial results at many major multinational corporations, slowing earnings growth. Meanwhile, the poor economic conditions worldwide that have led so many international investors to bid up the prices of U.S. investment assets bodes ill for global economic prospects, creating rising unrest and discord in areas like Greece.
In the end, the best path for investors to take in 2015 is not to focus so much on whether any particular year's returns will be good or bad. After all, the appropriate time horizon for a long-term investor lasts decades, rather than months, and relying too much on a steady rise in your portfolio year in and year out will leave you unprepared to handle the inevitable stresses of short-term pullbacks. So rather than focusing on the short-term implications of a less-than-stellar January, smart investors have plans to cover all contingencies, both positive and negative -- and in fact, a pullback in 2015 could be exactly what many people need in order to give them a more attractive entry point from which to put their money to work in the stock market for their long-term future.