What does January have to say about the year ahead?

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Graham Smith - Market Commentator

11 January 2019

Unlike alchemy, shortcut ways to beat the stock market retain a fascination. Many supposed seasonal effects get a regular mention in investing circles, such as Sell in May, or the Santa Claus rally that’s expected to reward investors in December.

We don’t have to retrace our steps far to find the Santa Claus rally failed in 2018. It’s hard to find a low point on markets in December from which investors could have made money by the end of the month, especially after taking dealing costs into account.

So what about the January effect? This supposed phenomenon has a number of interpretations. One subscribes to the idea January is a favourable month all round, while another suggests it’s a good time to have investments in smaller companies.

Other interpretations are based on the supposed predictive capabilities of the month. How markets fare in January, according to some, might be a guide to what will happen over the remainder of the year.

One of the inherent problems with seasonal patterns is they can’t work all of the time. If they did, markets would always discount them in advance, thereby preventing them from happening.

However, before we dismiss the January effect, it’s worth considering what might lie behind it. It would make sense that investors are more than usually predisposed to making a start on or reviewing their financial planning around the start of a new year. It may also be the time when individuals are starting to put their Christmas bonuses to work.

Another factor could be at work as well – a tendency for stock markets to perform better over the winter months. This effect is based on the idea that poor weather makes us more pessimistic. When optimism is at a premium, it’s more likely markets will be focused too much on risk factors, leaving room for prices to rally in the event things turn out OK¹.

Since markets are driven by humans, and humans by emotion and sentiment, all of these factors make intuitive sense. So, while it’s certainly the case that any predictable event will be gobbled up by an efficient stock market until it no longer exists, a tendency for January to be a good month for investors might not be completely unexpected. Well, the proof of the pudding is in the eating, so what of the relatively recent past?

Unfortunately for statisticians, results for the FTSE 100 Index don’t inspire confidence. Since the beginning of this century, the Index has risen six times in January and fallen 13 times. As a predictor it’s barely been any better than the toss of a coin, correctly indicating returns for the year only about half the time – in ten out of 19 years².

It’s true the test period we’re looking at encompasses some significant bear market events – the bursting of the dotcom bubble at the beginning of the century, 9/11 and the global financial crisis – but even through this challenging period, the FTSE 100 posted a positive annual return no less than 11 times.

If the January effect did exist – and studies popularised in the past have suggested that – then it may indeed be that modern-day markets have become good at nullifying it.

If that’s right, we have arrived at yet another reason for believing that trying to time markets is an unreliable method of accumulating wealth. Markets can have a habit of moving the wrong way at just the wrong time for investors dipping in and out.

The problem is exacerbated by psychology. It’s much harder to invest after big falls – at which point the outlook probably looks bleak – and, perhaps, equally hard to resist the fear of being left behind after a big rise.

At these extremes, money management as well as market timing becomes critical. Confidence, or a lack of it, may urge investing more than is appropriate when markets are high, or too little when they are low. 

One approach that circumvents these weaknesses is the regular monthly savings plan. It is no respecter of either human emotions or the whims of market sentiment, because it dispassionately invests a set amount each month. 

In so doing, it automatically capitalises on short term shifts in market sentiment, because more investment units or shares get bought when prices are low, and fewer when prices are high. Perhaps the regular savings plan is the ultimate money manager, and a much better way to really beat the stock market than tired seasonal shortcuts. 

Source:
¹ Federal Reserve Bank of Atlanta, October 2003
² FT, 31.01.17 and London Stock Exchange, 08.01.19

Important information

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