GREAT BARRINGTON — January was one of the worst months in history for the stock market, as the Standard & Poors 500 Index of stocks dropped about 5.1 percent.
But it wasn't the worst ever January slump for the S&P 500. That occurred in 2009 when the market fell 8.6 percent at the tail end of the Great Recession.
What lessons can we learn from historical data?
First, let's review the worst January returns in history. In addition to January 2009, other recent bad Januarys include 2008 (down 6.8 percent), 2010 (down 3.7 percent), and 2014 (down 3.6 percent). Of the 88 years for which we have data, there have been 21 with drops of at least 3 percent in January, not including 2016.
Let's look at what the returns were for the full calendar year after these 21 bad starts. It should come as no surprise that average returns have been poor in the years with bad Januarys. The average calendar-year return for these 21 years was minus 2.1 percent (including January returns). There are many examples where a rough January continued through the calendar year, but there are several examples where a poor January led to a turnaround during the rest of the year.
It's difficult to divine a precise trend from these data. Some of the bad years, like 1957 and 2008, were in the midst of recessions. Others, like 1940 and 1941, took place amid larger global events (World War II). Still others, like 1977, were the result of currency devaluation and oil shocks during a long-term bear market.
On the positive side, three of the best calendar-year returns among these 21 have occurred in recent history (2009, 2010, and 2014) during this long-term bull market. In those years, the market ended up with excellent annual returns of 23, 13, and 11 percent for the calendar year. That's quite the turnaround.
What if we exclude January and look at the rest of the year? After all, what's done is done and what matters now is the future. What happened from February through December in the 21 years where the market dropped at least 3 percent in January?
As it turns out, the average return for the rest of the year during these 21 bad starts was plus 3.1 percent. This compares with a 7.4 percent average annual return across all years. This suggests that the market might turn around for the rest of the year, but historically the return after a bad January has been less than average.
We know that even during good stock market runs, we can expect corrections. Nearly two-thirds of all years in history have seen market corrections of at least 10 percent at some point during the year. The January 2016 correction was alarming because it came at the outset of the year, but these kinds of corrections happen all the time, even in the course of a long-term bull market.
Is this January a sign of things to come, or a correction in the midst of a broader bull market? We cannot know that answer until the year plays out. These kinds of market pullbacks are precisely the reason I tell people not to try to time the market, and to invest in a prudent portfolio that includes bonds, even when it looks like the returns might be small. Most people — financial advisers and investors alike — "missed" the current correction. A diversified portfolio that includes bonds has not suffered the same setbacks as the stock market and should not cause as much pain for investors.
Note: All returns noted in this column are price-only returns on the S&P 500, meaning they do not include dividends.