What the Dow's Huge January Means for 2013

The stock market has gotten off to an incredibly strong start to begin 2013, with the Dow Jones Industrial Average (^DJI 0.59%) posting a nearly 6% gain in January, its best performance to start off a year since 1994. The bullish optimism only grew yesterday, as the Dow rose above the 14,000 mark for the first time since before the financial crisis.

The big advance has tempted many investors into putting more money to work in stocks. But when most investors are being greedy, it's often smart to have at least a little fear about whether those big gains will last. Let's take a look at some of the drivers of the Dow's huge performance with an eye toward evaluating whether the bull market will reach and go beyond its fourth anniversary in the months ahead.

Oh what a relief it was
Interestingly, much of the rally came less from outright positive news than from the fact that investors avoided worst-case scenarios on a number of important issues. With the fiscal-cliff compromise on New Year's Day, very few investors were truly happy with the narrow scope of the resolution and the failure to address longer-term structural problems with the government's budget, but avoiding a much broader tax increase on the entire country helped to prevent what could have been a much larger drag on the economy.

Similarly, expectations before earnings season started were extremely low, as analysts cut their estimates gradually on hundreds of companies in advance of their earnings releases. Many of those companies saw nice gains just for surpassing these more modest expectations. For instance, Procter & Gamble (PG -0.67%) was up nearly 11% after reporting stronger gross margins and organic sales growth, beating analyst estimates for flat year-over-year earnings-per-share performance. Similarly, Caterpillar (CAT 1.82%), which had reined in forward-looking guidance last year, managed to power ahead by nearly 10% despite seeing net income cut by more than half. Travelers (TRV -0.25%) gained more than 9% largely because it didn't lose nearly as much from Hurricane Sandy as investors had feared.

Guidance was also important in pushing certain stocks higher. P&G raised its own earnings projections for the year, adding to share repurchases and looking for further sales gains in the second half of its fiscal year. For Travelers, the disaster-prone past couple of years have helped the insurance company boost premiums, setting the stage for permanent gains in net income if casualty loss levels revert to more normal conditions. On the other hand, even further warnings that 2013 could be a tough year for Caterpillar didn't dampen enthusiasm in the stock.

For the big movers in the Dow from last year, January was a time for mean reversion. Hewlett-Packard gained back 16% after plunging last year, as value investors jumped into the stock in hopes that it will be able to continue its recovery. Bank of America (BAC 0.17%), on the other hand, was one of just two Dow stocks to decline, as another big settlement depressed earnings.

What's next?
Of course, the obvious question after a strong month is what relevance it has for the market going forward. On one hand, historically, years in which stocks posted significant gains in January have usually seen those gains grow over the rest of the year. Yet looking back to just last year, stocks continued their strong run throughout the first quarter, only to give back all their gains during April and May on fears that the aging bull market would come to an end because of various domestic and international economic pressures.

Certainly, investors are more bullish than ever. Stock mutual funds had extremely high levels of inflows during January, reflecting the general excitement over the market's advance. Yet in the past, increasing investor interest has been a contrary indicator, as the general public tends to buy stocks as they're approaching their highs, missing out on the early parts of a long bull run -- as they did from 2009 through 2012.

You shouldn't take January's big gains as a certain sign that the stock market will continue powering ahead for the rest of 2013. By keeping an even keel and understanding both the bullish and bearish arguments on stocks right now, you'll put yourself in the best position to profit no matter what happens to the overall market.