Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
The Dow Jones Industrials (DJINDICES:^DJI) finished January with a loss of 878 points, qualifying as a minor correction with its 5.3% decline. That loss has many investors nervous, given what they see as a negative track record for the stock market in years when returns in the first month of the year aren't promising. But when you take a closer look at the actual performance of the Dow recently, you'll find that a down January guarantees nothing about the future course of the stock market.
The worst case
Of course, there are plenty of situations in which a poor year has followed a down January. The most obvious example is 2008, in which the Dow kept dropping from its late-2007 record highs and fell 615 points in January, almost a 5% move. That proved to be the beginning of what would culminate in the financial crisis, with the Dow ending the year down 34%.
Less dramatic examples include 2005, when the Dow declined about 2.7% in January. The average actually regained some of that lost ground during the remainder of the year but still ended 2005 with a slight loss overall. Subpar performance in 2000 and 2002 also support the down January theory.
Plenty of counterexamples
At the same time, though, there have been many instances in which a loss in January didn't result in a terrible year for the market. In fact, in recent years, that has almost become the rule rather than the exception.
In 2010, the Dow fell by 3.5% in January, leading many to believe that the more than 50% jump from the Dow's 2009 lows had run its course. Yet the Dow only fell another 200 points or so before hitting bottom and regaining altitude. By the end of the year, the Dow had climbed almost 1,150 points for the year, and we all know how well the stock market did during the ensuing three years compared to its closing level of 11,577 at the end of 2010.
Similarly, in 2009, the Dow plunged almost 9% in January, defying hopes that the average had already hit bottom during the terrifying fall of 2008. Even after a 775-point decline, the Dow would go on to fall more than 1,500 points further before hitting bottom. By the end of 2009, the stock market had not only recovered all of its losses but picked up an impressive 1,650 points -- about a 19% return not including dividends.
In addition, even in years when the overall Dow obeys the down January rule, individual stocks can often move in the other direction. In 2008, Wal-Mart (NYSE:WMT) defied the Dow both in January and throughout the year, with the retail giant using its recession-resistant reputation to post huge 20% gains even in a terrible year for stocks. McDonald's (NYSE:MCD) went further, falling in January 2008 but ending the year up almost 10%. Both stocks succeeded by catering to the value-conscious attitude that consumers had during the worst of economic times.
Don't pay attention to the noise
The thing about statistically suggested indicators like the down January theory is that they never hold true 100% of the time and are misleading in their implication that there's any causal relationship that makes the indicators determinative. In this case, January performance and negative overall annual returns don't have a strong enough link that investors can rely on the indicator's track record. As a result, taking action based on it is just another example of market timing. That's not a trap that any long-term investor wants to fall into in their investment strategy.