As goes January, so goes the year?

Have you heard about the ‘January effect’? If you have, don’t let it sway your judgment.

According to the theory of the ‘January effect’, the way that stock market prices move during the month of January signals the likely outcome for the year ahead – whether stock markets will rise or fall. In other words, if the return in January is negative, this would supposedly foreshadow a fall in the stock market for the remainder of the year, and vice versa.

To examine this idea, let’s look at the world’s largest stock market – the US – which provides more than 90 years of reliable data. Have the past January returns of the top 500 companies in the US, the S&P 500, been a reliable indicator for what the rest of the year has in store? If so, and if returns in January are negative, should investors sell equities?

Our chart shows the monthly returns of the S&P 500 Index for each January since 1926, compared to the subsequent 11-month return (i.e., the return from February through to December). A negative return in January was actually followed by a positive 11-month return about 60% of the time, with an average return during those 11 months of around 7%.

Therefore, this data suggests that there may in fact be an opportunity cost for abandoning equity markets after a disappointing January. Take 2016, for example: the return of the S&P 500 during the first two weeks was the worst on record for that period, at -7.93%. Even with positive returns towards the end of the month, the S&P 500 returned -4.96% in January 2016, the ninth worst January performance observed from 1926 to 2017. But a subsequent rebound of 18% from February to December resulted in a total calendar year return of almost 13%. An investor reacting to January’s performance by selling out of equities would have missed out on the gains experienced by investors who stuck with equities for the whole year. This is a good example of the potential negative outcomes that can result from following investment recommendations based on a theoretical ‘effect’ – particularly when that ‘effect’ doesn’t seem to hold water.

Over the long term, the financial markets have rewarded investors. People expect a positive return on the capital they supply, and historically, the equity and bond markets have provided meaningful growth of wealth. As 2018 progresses, all investors should remember that frequent changes to an investment strategy can hurt performance. Rather than trying to beat the market based on hunches, headlines, or dubious theories, investors who remain disciplined can let markets work for them over time. However, for those still tempted to gamble, the figures for January 2018 for the US and UK were S&P 500 + 5.73% and FTSE 100 -1.96%.
January return vs. subsequent 11-month return of the S&P 500 Index 1926–2017

In US dollars. S&P 500 Index data provided by Standard & Poor’s Index Services Group. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

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