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In the Market - January 2010
Jan 15, 2010
The Other January Effect
When people think of the January effect they are usually referring to the phenomenon of small cap stocks outperforming large cap stocks in the month of January which is often attributed to tax loss selling of small cap stocks in December. There is however, another January effect that has also shown promise—equity performance in January as a good predictor of the equity markets for the rest of the year.
We looked at S&P 500 January returns from 1950 to the present. During this time, the index posted positive results 37 times in the month of January, with average returns over 4%. Of those 37 years with a positive return in January, a surprising 33 or 89% of these years showed positive full year results, with average gains of over 11%. Conversely, the 23 times the S&P had a negative return in January, the rest of the year has been split with gains and losses, with average losses of just over 2%.
Numerous behavioral reasons could explain this January effect.
- Both individual and corporate budgets are set at year end so healthy January's may bode for a healthy year.
- 401K contributions are usually evenly distributed throughout the year, but are set at the beginning so January's inflows may be indicative of the rest of the year.
- January's performance can be an indication of investors' views on risk and a strong January means that investors are optimistic about the market and in the absence of reasons to change their minds the bullish trend has historically continued.
Many investment strategies become less profitable after they become well known, but after the big swings in the market there still may be some opportunity left. The S&P has had a very strong first two weeks so it will be worth watching how it holds up for the rest of the month as an indicator for the rest of the year.