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The January Barometer

The January Barometer, sometimes also referred to as January effect (although the January effect is a different thing), is the theory according to which market performances during the month of January can be used to predict the trend for the rest of the year. The January Barometer theory is often summarized by the saying: “As goes January, so goes the year”. The practical implications are rather straightforward: if the asset class under examination has a positive return in January, the theory suggests that it will be a bullish year while a negative performance should predict a bearish trend for the upcoming months. The January Barometer theory is based on the assumption that many fund managers and institutional investors, particularly those who are interested in medium–to–long term investments, at the beginning of each new year, will tend to place their positions already discounting their view on the next 6 to 12 months. Consequentially, the theory suggests that, should the view be negative, portfolio managers will position themselves on the short side of the market at the beginning of January. Otherwise, should they think the price action will go up in the next 6 to 12 months, they will go long. Hence, the theory is based on the fact that the buying or selling pressure generated by the amount of money allocated in the market by big players in January should move the price in the direction of their forecasts. This is the theory but as Albert Einstein stated: “In theory, theory and practice are the same. In practice, they are not”. The present research aims to investigate and study the reliability of the January Barometer theory in order to assess, under a probabilistic point of view, what are the chances to actually earn consistent profits if applied to financial markets. The research has been carried out on major equity indices in the world that have been, in turn, subdivided for geographical location: North America (S&P500, NASDAQ Composite), Europe (DAX30, FTSE100), AustralAsia (Nikkei225, ASX200) and Emerging Markets (Hang Seng, Bovespa, BSE Sensex). The dataset that has been used consists of index prices ranging from January 2004 until December 2014 implying 11 years worth of data. The back testing analyses that will be exposed and commented are simply aimed to understand if January’s market returns matched, if not in size at least in sign, with yearly ones. Hence, the combination negative return in January/negative yearly return as well as the combination positive return in January/positive yearly return will all be calculated as success cases. On the other hand, all non–matching returns will be treated as a failure of the theory. The results of the analyses will be presented and explained by geographical location, hence, the first equity indices that will be analyzed are the North American ones:

yearly returns: S&P500, NASDAQ Composite

The above reported table shows, in the first column, January’s lognormal returns calculated for the S&P500 while the second one lists the total return for each year. The right hand side of the table provides the same calculations but based on the NASDAQ Composite index. First of all, it is worth noting that, over the last 11 years, the average return for the S&P500 index has been +4.89% while the NASDAQ Composite yielded an average of +6.78%. Secondly, both equity indices have experienced similar fluctuations during the crises but the NASDAQ has consistently outperformed the S&P500 since the 2012 so far. The following chart plots the success/failure rates of the January Barometer theory applied to the aforementioned asset classes over the last 11 years:

success/failure rate: S&P500, NASDAQ

The success rate for both S&P500 and NASDAQ Composite is 54.5% while the failure rate is 45.5%. These numbers simply mean that the JB theory held true for 6 years but it unsuccessfully predicted yearly returns in 5 occasions. Nevertheless, the 54.5% success rate definitely does not fall within the category “reliable strategies” but different results could potentially come from different markets. The next table presents the results of our analyses on the German DAX30 and the British FTSE100:

yearly return: DAX, FTSE100

The tables evidently show that during the financial crises in 2008, the selected European markets performed as poorly as their American counterparties (although the British FTSE100 did not violate the –40% threshold). The last 3 years have gone quite well as far as returns are concerned although in the 2014 the British FTSE100 (–2.62%) underperformed the DAX30 (+3.06%). On average, the German index, over the last 11 years, has yielded a +7.26% return while long term investors in the British market managed to gain only +2.34%. The next graph plots the success/failure rates of the January Barometer theory applied on the aforementioned European asset classes:

success/failure rate: DAX, FTSE100

The results are very different from the ones observed for the overseas equity indices. First of all, the JB theory applied to the DAX30 has higher failures (54.5%) than successes (45.5%). In particular, the January Barometer strategy has successfully predicted future returns 5 times but it has failed 6 times implying that even in this market it led to poor results. On the other hand, the JB applied to the British FTSE100 shows a 63.6% winning chance while the losing probability is only 36.4%. In this case, the returns registered in the first month of the year since 2004 proved to be good forecasters for yearly returns. Numerically, the JB strategy would have been profitable in 7 cases while it would have failed only in 4 occasions. The next table lists the historical returns for the AustralAsian region:

yearly return: NIKKEI225, ASX200

The equity indices that have been used as a proxy for the AustralAsian geographic region are the Japanese Nikkei225 and the Australian ASX200. The 2008 was a very negative year also in AustrlAsia, in fact, both yearly returns are very close to the –50% threshold. However, also the European credit crisis in 2011 has dramatically influenced the aforementioned indices: –20.58% for the Nikkei225 and –13.16% for the ASX200. The data for the average returns, calculated over the last 11 years, show that the Nikkei225 yielded a +2.89% while the Australian equity index returned an average of +3.57% to potential long term investors. Did the January Barometer strategy provide any extra gains? The next chart will attempt to answer this question:

success/failure rate: NIKKEI225, ASX200

The Japanese index displays the usual 54.5% / 45.5% split between success and failure rates implying that the JB strategy proved profitable only 6 times and failed in 5 cases. Conversely, the success rate for the ASX200 is 63.6% (7 successes) while the failure rate is only 36.4% (4 failures) implying that the JB strategy was definitely more profitable when applied to the Australian index than to its Japanese equivalent. The last table of the present research focuses on the past performances of a geo–economic, rather than merely geographic, area: emerging markets.

yearly return: Hang Seng, Bovespa, BSE Sensex

The equity indices that have been selected for this section are the Hang Seng (Hong Kong), the Bovespa (Brazil) and the BSE Sensex (India). The first thing to notice is that during the crisis the losses incurred by these markets have been larger than the ones observed for the indices we have mentioned so far. In fact during the credit crunch, with the exclusion of the Brazilian Bovespa that in 2008 had a negative return of “only” 46.25%, the Hang Seng yielded a –55.43% while the Indian return for the same year was a remarkable –70.64%. However, the scenario considerably changes if the 2011–2014 time interval is taken into account. In fact, the Indian equity index, even including the drop in the 2011, has consistently outperformed the other two. As far as long term average returns are concerned, since the 2004 so far, the Hong Kong’s Hang Seng yielded a +5.43%, the Brazilian Bovespa returned a +5.81% while the Indian BSE Sensex averaged an impressive +13.68%. Emerging markets average returns are clearly very high but the BSE managed to outperform all other equity indices considered in the present research (the German DAX30 ranks second with a +7.26% and it is immediately followed by the NASDAQ Composite index that yielded an average return of +6.78%). The next chart plots the success/failure rates obtained by running the January Barometer strategy on the Hang Seng, Bovespa and BSE Sensex:

success/failure rate: Hang Seng, Bovespa, BSE Sensex

The success rates for the BSE Sensex (54.5%) and Bovespa (45.5%) do not really seem to provide a hedge (although the strategy proved more profitable on the Indian equity index than on the Brazilian one). The most significant information that can be extracted from this analysis is the high failure rate on the Hong Kong’s index (63.6%). In particular, the January Barometer strategy has consistently failed to predict yearly returns on the Hang Seng index for 7 years while it proved successful only in 4 cases.

All in all, the analyses just conducted on the 9 equity indices considered in the study seems to point out that the JB strategy does not to provide any particular hedge for investors. Nevertheless while wrangling data some interesting patterns have emerged. The patterns that have been detected can be grouped in two categories: the winning pattern and the losing pattern.

Winning Pattern

The January Barometer strategy can only yield two mutually exclusive outcomes: it is either profitable or not (there is a chance that the yearly return could eventually be 0% but the associated probability, over 252 trading days, is so low that we have voluntarily excluded it from the scenario analysis). The winning pattern has been extracted by simply running a frequency analysis on the times the JB strategy proved to be profitable. The JB strategy basically states that January’s return should match the yearly one, however, it makes no difference between negative or positive returns. Consequentially, as stated at the beginning of the research, a positive January’s return in a positive year would be counted as a success but a negative January’s return in a negative year would be also counted as a success. The most important thing for the strategy to work is a match between returns. The questions this section is trying to give an answer to are: is there a pattern among success cases? Do success cases have anything in common? Do bullish success cases outnumber bearish ones or vice versa? Before showing the results, it is worth reminding that 11 years worth of data on 9 different asset classes have been filtered implying a total of 99 observations. 52 out of 99 observations fall into the winning pattern category while the remaining 47 are axiomatically assigned into the losing pattern one. The following pie chart attempts to summarize the results obtained from data mining the data associated to the first pattern:

successes: bullish year vs bearish year

The success cases, for the combination January’s positive return in a positive yielding year (green area called BULL), are 34 while the success cases, for the combination January’s negative return in a bearish year (red area called BEAR), are only 18. Clearly, the outcome of this frequency analysis is a consequence of the overall trend in each year but it seems that the JB strategy, when profitable, works best in positive performing years rather than in negative ones (winning pattern). In order to understand why this is the cases we have to proceed and mine the data for failure cases.

Losing Pattern

In the previous section it has been observed that, numerically speaking, the majority of success cases happened during the combination January’s positive return in a positive yielding year. It has also been stated that the JB strategy “works best in positive performing years rather than in negative ones”. However, in order to understand why this is case, the present section will analyze all failure cases. If the JB strategy did not work, it axiomatically implies that January’s return did not match the sign of the yearly one. Consequentially, there are only two scenarios to consider when analyzing failure cases: the return in January was positive but the yearly one turned out to be negative or the year started by yielding a negative return in January but it ended with a positive performance. The next pie chart plots all the failure cases and groups them into two categories: BEAR TO BULL (negative return in January but positive on a yearly basis) and BULL TO BEAR (positive return in January but negative on a yearly basis):

failures: bear to bull years vs bull to bear years

The above reported chart is evidently displaying that, among failures, there is a very frequent pattern: the vast majority of failures in the JB strategy are due to years starting out with a negative return but that subsequently yield a positive one (losing pattern). Numerically speaking, the BEAR TO BULL cases counted 39 observations while the BULL TO BEAR ones are only 8.

Conclusion

  • The January Barometer strategy does not seem to provide consistent profits at least for the considered asset classes and the selected time frame
  • The January Barometer strategy successfully predicted yearly returns in 52 cases (52.5% of the total observations)
  • 34 of the 52 success cases come from the combination January’s positive return in a positive yielding year while only 18 come from the combination January’s negative return in a negative yielding year
  • The January Barometer strategy failed to predict yearly returns in 47 cases (47.5% of the total observations)
  • 39 of the 47 failure cases fall within the BEAR TO BULL category where January yielded a negative return but the year ended up with a positive performance
  • Only 8 failure cases fall within the BULL TO BEAR category where January yielded a positive return but the year ended up with a negative performance

 

The present research can be expanded in many ways. In fact, potential research developments could come from increasing the datasets in order to allow 20 or 30 years worth of observations, from including more equity indices or by expanding the analysis to different types of asset classes such as treasury bonds, commodities and currencies.

E-Mini S&P500 Futures Volatility Forecast (05/10/2011)

E-Mini S&P500 futures opened at 1,158 on Monday, achieved 1,170 on Tuesday, plummeted to 1,149 on Wednesday, and rose to 1,157 on Thursday but on Friday the price dropped to 1,122 in the last minutes of the trading session.

The current volatility is 2% (31.7% annualised) and the plot is still showing a volatility curve which is trading at very high levels but now moving laterally with a shy downward sloping tendency.

The conditional variance is indeed very high but it is likely that the mean reverting process will start to become more and more “heavy” meaning that the volatility curve will probably tend to mean revert towards the next hours even if it will be unlikely to see a full and complete return to the long term equilibrium point.

The HyperVolatility team is bullish E-Mini S&P500 futures because the softening of the oscillation rate should support the price action which could potentially achieve the 1,180 – 1,200 area by Friday.

Nevertheless, unexpected bad news could drag futures prices back down and this time, should this happen, a retesting of the 1,000 support would be almost inevitable.

E-Mini S&P500 Futures Volatility Forecast (19/09/2011)

E-Mini S&P500 futures opened at 1,163 on Monday, rose to 1,171 on Tuesday, jumped to 1,187 on Wednesday, achieved 1,211 on Thursday and closed at 1,214 on Friday.

The actual volatility is 1.4% (22.2% annualised), which is still a fairly high value if we consider an average fluctuations rate of 0.7% – 0.8% (11.1% -12.6% in annual terms), but the slope of the curve is now clearly downward sloping. Hence, the upcoming days should see an ulterior flattening of the conditional variance which, ceteris paribus, should complete the mean reverting process and settle around the abovementioned average values.

The current week does not present much macro-economic news coming from the States, apart from the FOMC announcement, and as a consequence most of investors’ eyes will focus on the European sovereign debt crises.

The HyperVolatility team is moderately bullish E-Mini S&P500 futures because, should the volatility keep in its downward trend, the price could touch the 1,230 – 1,240 by Friday.

The market remains highly unstable and any bad news coming from European politicians is going to provoke a short term sell-off which would completely twist our analysis.

E-Mini S&P500 Futures Volatility Forecast (06/09/2011)

E-Mini S&P500 futures opened at 1,208 on Monday, tested the 1,204 level on Tuesday, achieved 1,219 on Wednesday, plunged to 1,201 on Thursday and closed at 1,169 on Friday.

The actual volatility is 1.52% (24.1% annualised) and the TGARCH plot is evidently displaying an upward sloping curve which seems suggesting that an ulterior augment in the oscillation rate should be expected over the next trading days. Obviously, last Friday’s market drop considerably influenced the fluctuations rate but it is worth pointing out that the mean reverting speed started to decrease well before Friday. Should the market keep plummeting we could see readings around the 2.5% (39.6% in annual terms) by Friday again.

The HyperVolatility team is bearish E-Mini S&P500 futures because the expected increase in the conditional variance is going to drag the price action back down into the 1,110 area by Friday.

It is worth pointing out that the situation could completely change should Obama or Bernanke announce a new fiscal/monetary stimulus package because many investors who got burnt after the August sell-off would probably get back to buy equities or increase their exposure to risky markets.

E-Mini S&P500 Futures Volatility Forecast (30/08/2011)

E-Mini S&P500 futures opened at 1,124 on Monday, rose to 1,158 on Tuesday, achieved 1,171 on Wednesday, plummeted to 1,157 on Thursday and closed at 1,175 on Friday.

The current volatility is 2.2% (34.9% in annual terms) and the TGARCH plot displays a sideways movement of the volatility curve which clearly implies the fact that many traders and investors have been waiting for Bernanke’s speech. The conditional variance is still extremely high and the mean reverting process should manifest itself over the next trading hours although some short term volatility increases are quite likely to occur.

However, it is important to point out that the overall interpretation of the chart highlights that a softening of the market fluctuations rate is quite likely to happen.

The HyperVolatility team is bullish E-Mini S&P500 futures because the decrease in market volatility should favour a recovery of the price which could eventually retest the 1,230 points by Friday.

It is worth noting that the majority of investors and traders will focus on the macroeconomics news such as manufacturing index, NFP and initial jobless claims and therefore a great deal of attention will be needed during their announcement.

E-Mini S&P500 Futures Volatility Forecast (22/08/2011)

The market headed north in the first half of the week, meeting our last week’s expectations, but the disappointing figures related to the US manufacturing industry and the medieval approach to economics that some European politicians have, certainly helped to destroy investors’ confidence even further.

E-Mini S&P500 futures opened at 1,196 on Monday, dropped to 1,192 on Tuesday, plummeted to 1,189 on Wednesday, plunged to 1,144 on Thursday and closed to 1,123 on Friday.

The current volatility is 2.6% (41.2% in annual terms) and the TGARCH plot is showing an insistently upward sloping curve which seems suggesting that the upcoming days will see an ulterior increase in the oscillation rate although the present readings are well higher than the equilibrium point and still dangerously close to what we saw in the 2008- 2009 crash.

The HyperVolatility team remains bearish E-Mini S&P500 futures because the conditional variance is still very high and the VIX Index is not showing any sign of rest. There will be some short term uptrend but the overall week should not see a robust recovery of the price because it will take some times for the market to attract some buyers.

We expect futures prices to plunge over the next trading days and eventually retest the 1,000 level by Friday. No long position should be entered during this week even if the market could potentially show some movement on the upside.

This week all eyes will be on Europe because quite a few macroeconomics data are going to be released but on Friday a great deal of attention will be needed since investors will switch the focus on Bernanke’s speech.

E-Mini S&P500 Futures Volatility Forecast (14/08/2011)

The HyperVolatility team was right once again and the profit targets we suggested the last week have been successfully hit by futures prices making our analysis, once again, accurate and profitable. In particular, E-Mini S&P500 futures opened at 1,111 on Monday, rose to 1,171 on Tuesday, dropped to 1,123 on Wednesday, rose to 1,168 on Thursday and closed at 1,177 on Friday.

The actual volatility is 3% (47.6% annualised) and the TGARCH plot is evidently showing a downward sloping curve whose mean reverting process seems to be on its way. The fluctuations rate should decrease over the next trading hours because the conditional variance will try to settle around the 1% threshold (15.8% in annual terms) even if a short term, although not violent, increases of volatility are very likely to occur along the way down.

It is worth noting that this week most of the macroeconomics news coming from the US has been encouraging: better than expected initial and continuing jobless claims, better than expected core sales and lower than expected Federal budget deficit.

The HyperVolatility is bullish E-Mini S&P500 futures because the plummeting volatility curve is a clear signal that the down movement is now over and that many investors and traders are now buying back the market.

Moreover, the positive macroeconomics news and the decrease in the fluctuations of the VIX are all factors that are pointing towards a recovery of the price action. E-Mini S&P500 futures should eventually touch 1,250 – 1,260 points by Friday, credit rating agencies permitting.

E-Mini S&P500 Futures Volatility Forecast (08/08/2011)

The American economy has been hit by very bad macroeconomics figures and the US debt ceiling problems accentuated traders ‘concerns dragging the index down. Specifically, E-Mini S&P500 futures opened at 1,279 on Monday, dropped to 1,247 on Tuesday, rose to 1,254 on Wednesday, plummeted to 1,199 on Thursday and closed at 1,197 on Friday.

The volatility is now 1.78% (28.2% annualised) and the TGARCH plot is undoubtedly upward sloping implying that the big drop is far from being over. Particularly, the volatility does not show any retracement and its explosion was as rapid as “clean” (with no short term fluctuations of the curve) and consequently it is very probable that the conditional variance will keep augmenting over the next hours.

The US debt concerns, the S&P downgrading of US sovereign debt, the bad macroeconomics data about the manufacturing industry, the concerns about a potential default of big European countries have completely knocked down investors’ confidence and the panic is the only thing left in the market.

Furthermore, the slightly better than expected news coming from the NFP did not really help market sentiment even if on Tuesday the FOMC will try to regain a bit of credibility.

The HyperVolatility team is extremely bearish on E-Mini S&P500 futures because the oscillation rate should increase even more over the next hours dragging the price back down in the 1,050 – 1,100 area by Friday.

Beware of market up movements because, with this volatility, they are more likely to be bull traps rather than a bargain opportunity.

E-Mini S&P500 Futures Volatility Forecast (02/08/2011)

E-Mini S&P500 futures opened at 1,333 on Monday, dropped to 1,326 on Tuesday, plummeted to 1,299 on Wednesday, settled at 1,297 on Thursday and closed at 1,292 on Friday.

The actual volatility is 1% (15.8% annualised) and the TGARCH plot is evidently displaying a volatility curve which has dropped significantly over the last two weeks but that sharply mean reverted and jumped back up again during the last 5 trading days. Furthermore, the conditional variance seems now “intentioned” to trade within the actual ranges even if the fair equilibrium point for this market is around the 0.65% – 0.73% threshold (10.3% – 11.5% annualised).

Many markets are now close to break through their 2 years highs and the 1,350 – 1,360 threshold is the E-Mini S&P500 futures obstacles that bulls will have to overcome if they want to see the market keeps rallying higher. Specifically, the price action attempted to surpass this level quite a few times in the past but it never successfully managed to remain above it for a time sufficient enough to boost investors’ confidence.

The HyperVolatility team is bullish E-Mini S&P500 futures because the volatility plot shows a fairly robust curve which should keep the weekly average price up. In particular, we expect the 1,330 – 1,335 area to be retested by Friday even if some short term explosions of the conditional variance could easily bring back down futures prices (particularly in the first half of the week).

E-Mini S&P500 Futures Volatility Forecast (24/07/2011)

E-Mini S&P500 futures, like many other equity indices, rallied consistently throughout the entire week and retested the 1,345 – 1,350 area. The market opened at 1,300 on Monday, rose to 1,321 on Tuesday and remained to this level on Wednesday too but on Thursday it jumped up to 1,342 and closed at 1,340 on Friday.

The current volatility is 0.43% (6.8% annualised) and the TGARCH plot is evidently showing a situation that is not sustainable in the long term because the downward sloping curve has just touched one of the lowest levels in 5 months.

The volatility will probably start to mean revert over the next trading days and settle around the 0.6% – 0.65% area (9.5% – 10.3% in annual terms) which is the equilibrium point for the conditional variance in the medium term.

The American Index has been moving laterally since the middle of May and the price action has been consolidating for more than 2 months just below the resistance point placed at 1,350.

The HyperVolatility team is moderately bearish on E-Mini S&P500 futures because the conditional variance will almost certainly augment over the next hours bringing some more instability to futures prices.

We believe that, in the first half of the week, the Index will keep moving sideways with occasional attempts to break through the aforementioned resistance level; however, in the second half there should be a short term retracement, favoured by an increased confidence of bears, which will bring E-Mini S&P500 futures back down in the 1,310 – 1320 area by the next Friday.

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