'Investors should expect a good year for equities'

In 1972, Yale Hirsch, author of the Stock Trader’s Almanac, devised the January Barometer, which states that as the S&P index goes in January, so goes the year. By 2005, the barometer had claimed a 90% success rate, with only five major errors, but results in recent years have been more mixed.

In 2020, a 0.2% loss predicted neither the Covid-related slump nor the strong subsequent recovery for an overall annual gain of 16%. In 2021, the market rose 27% despite a 1.1% fall in January. Sceptics also point out that the S&P has generated a positive annual return 75% of the time, so the correlation is mostly due to the upward march of the index.

For those who didn’t want to wait till the end of January, Hirsch also devised an early-warning system, noting that the first five trading days of the year constituted almost as good an indicator. For the even more impatient, he discovered the “Santa Claus rally,” the tendency of the index to rise in the last five trading days of the year and first two of the New Year. A failure to do so could signal a bear market, as it did in 2000.

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Hirsch attributed the success of the January Barometer to politics; Congress convenes in the first week, presidents are inaugurated on the 20th and the president gives the State of the Union message and presents the annual budget.

A more plausible explanation is that if investors feel optimistic in January, that mood tends to continue and vice-versa. In 2003, investors were understandably pessimistic after three down years in a row but the market rose 26% after a poor start. A 13% gain in 1987, the strongest January gain ever, led to euphoria and complacency; by the end of August, the S&P was up 40% on the year but, following the October crash, it closed the year up just 2%.

Fading seasonal patterns of markets

The January effect is just part of the seasonal pattern of markets. The reporting season for the previous calendar year starts in January, with accompanying guidance about the coming year. Share prices rise as uncertainty diminishes but this process is largely complete by the spring, by when prices may have run too far. With next year still a long way off, the temptation to “sell in May” (or earlier) is strong, followed by buying back in the autumn, when the following year comes into sight.

If markets haven’t sold off in the spring but keep rising, as in 1987, a sharp setback or crash is possible in the autumn. Conversely, if the year has been poor, investors may start to look ahead to better times. October is the month for crashes but also for about-turns. However, the increased focus on quarterly rather than annual results should diminish the seasonal pattern of markets, including the January effect, as it appears to have.

Rising markets are built on increasing corporate earnings while recessions undermine earnings thanks to disappointing turnover, write-offs and rationalisation costs. A recession in 2026 would be bad news for markets but of this there is little sign. Interest rates are not high; nor is leverage, and consumers have not overspent. Commodity price-driven inflation is not a threat.

Ed Yardeni of Yardeni Research expects the US economy to grow by 3%-3.5% in 2026 after 2%-2.5% this year. He expects 15% earnings growth in 2026 followed by 13% in 2027. On this basis, the S&P 500 trades on 22 times 2026 and 19.5 times 2027 earnings. This is demanding and there is no shortage of pundits, especially in the media, expecting the market to fall, led by the AI-related stocks. Other markets are more moderately valued and less vulnerable but if the US sneezes, the rest of the world usually catches a cold.

The most likely cause of a contraction in the market’s valuation is a rise in bond yields. Central banks, including in the US and UK, are under political pressure to reduce short-term interest rates in the fond belief that this will lower bond yields and thereby the cost of government borrowing. As the last year has shown, this is not necessarily the case. Investors are not convinced that lower rates are sustainable, and there is a mountain of additional government debt that will need financing.

Higher bond yields would be very likely to lower the multiple of earnings at which shares trade but, if earnings keep on rising, markets would be more likely to trade sideways or moderately down than see a major, sustained fall. As Sir John Templeton observed, markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.

Fund flows in the UK and sentiment indices in the US show that euphoria is a long way off. As Warren Buffett advised, “be fearful when others are greedy and greedy when others are fearful.” On that basis, it is certainly a time to be greedy in the UK and maybe in the US.

Finally, another old rule of thumb is to sell when markets are up 30% year on year and to buy when they are down 10%. The S&P 500 is up just 12% in the last 12 months and the UK 18%. A moment of danger will appear in early April on the anniversary of the 2025 sell-off, but it was soon recovered so the danger will pass. Euphoria is more obvious in the gold price, up more than 60% annually.

Readers of MoneyWeek are unlikely to have stood on the sidelines, watching others accumulate wealth in the stock market in recent years. We must hope that others get the message in 2026, in what should be another good year for markets at a time when deposit rates are falling, bond prices languishing and the bull market in gold is over.

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