This Indicator Says the Stock Market Is Going to Have a Great Year. Is It Right?

The first month of 2023 is in the books, and it was a banger for the stock market.

The S&P 500 finished the month up 6.2%, while the tech-heavy Nasdaq jumped 10.7%. This would qualify as an above-average gain for the stock market in a whole year, let alone one month.

After a brutal 2022, investors are now encouraged by signs that inflation is getting under control and the Fed will cool off with its interest rate hikes. The economy has withstood the pressure from higher interest rates and inflation so far, with the unemployment rate remaining low. While some sectors, like tech and transportation, are showing signs of a recession, the overall economy seems robust enough to rebound later in the year if inflation continues to cool.

The gains in January have added significance due to the January Barometer, a predictive indicator discovered by Yale Hirsch, the author of Stock Trader’s Almanac, in 1972. He found that there was a strong correlation between the performance of the stock market in January and its performance for the year. Hirsch also identified the correlative relationship between the Santa Claus rally and the stock market’s performance over the next year.

According to Hirsch and the January Barometer theory, the stock market’s performance for the year can be predicted by its performance in January. If the S&P 500 goes up in January, it will go up for the year, and vice versa.

From 1950 to 2022, the indicator has been accurate 85% of the time, missing 11 times. While not perfect, it has been mostly successful in predicting the stock market’s performance. Last year, for example, the S&P 500 peaked early in January and proceeded to fall over both that month and the rest of the year.

Like the Santa Claus Rally, there’s no direct causal relationship between the January Barometer and full-year performance, but the belief in it can have reinforcing effects. Additionally, both institutional and retail investors may be adjusting their strategies at the beginning of the year. This may include rebalancing, reinvesting tax-loss harvesting money or end-of-year money, and investing after making retirement contributions at the end of the year, which reflects the attitude toward the stock market for the year. 

This year, there does seem to be a good reason for the bullishness.

A green stock chart going up.

Image source: Getty Images.

Will the stock market go up this year?

The January surge didn’t happen in a vacuum. There’s a reason why tech stocks have outperformed — and why the Dow Jones Industrial Average was the worst performer of the three major indexes in January, rising just 2.8% after beating the other two in 2022. 

Investors are preparing for an economic rebound, buying stocks that are positioned to benefit from a more stable or even declining-interest-rate environment — like tech stocks, many of which look cheap after last year’s crash in the tech sector. Alphabet (GOOG 1.56%) (GOOGL 1.61%), for example, trades at a lower price-to-earnings ratio than the S&P 500. While that reflects the slowdown in the digital advertising industry, the Google parent still has a highly profitable search monopoly and a long history of outgrowing the broad market.

Last year’s sell-off was largely driven by high inflation and rising interest rates. But over the last six months, inflation is only up by an annualized rate of 1.8%, within the Fed’s target rate of 2%. If inflation continues to cool off, the Fed is likely to stop raising interest rates. In December, it said it expected to finish 2023 with the fed funds rate at 5.1%, implying 75 basis points of hikes, but that could change. 

Meanwhile, a number of high-profile companies, including MicrosoftIntel, and UPS, have reported weak results and guidance so far this quarter. But the market is forward-looking, and declining levels of fear are often the biggest factor in determining a market rebound. If investors believe a deep recession is more unlikely, that will support a recovery.

Don’t make this mistake

Trying to time the market is tempting, but it’s usually a mistake, as even expert investors can’t do it consistently. In this case, the market bottom may have already passed, but rather than trying to time the market, a better move is to stay invested so you don’t miss out on the rebound.

No one knows if the stock market will finish higher this year, but the January Barometer and the recent macroeconomic data point in the right direction. If you believe in the January Barometer, a 6% jump seems to bode especially well for the market’s performance this year. This could be just the start of a big year for stocks.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Intel, and Microsoft. The Motley Fool recommends United Parcel Service and recommends the following options: long January 2023 $57.50 calls on Intel, long January 2025 $45 calls on Intel, and short January 2025 $45 puts on Intel. The Motley Fool has a disclosure policy.