The January Effect: A Resolution Worth Keeping
It’s that time of year again to pull out our crystal balls and make yearlong predictions.
Much like New Year’s resolutions, however, few of these predictions will stand the test of time.
So, instead of giving you my full-year predictions for 2017, I’m going to take it one month at a time.
Let’s start with January, its impact on the stock markets and how you should position your portfolio today to take advantage of a unique phenomenon.
At the start of every new year, we see gym memberships spike as people try to make good on a New Year’s resolution.
These end up mostly being failed goals, as few stick to the new healthy lifestyle. But the inevitable spike in gym memberships still happens each and every year.
In the market, we see a similar seasonal trend that hits in January.
At the end of every year, fund managers dress up their portfolios by closing out of riskier small-cap stocks and cutting losses for tax purposes. This year is no different, and it will probably see an increase in such activity as many expect lower tax rates under a Trump administration.
The cash makes its way to the sidelines at the end of the year and works its way back into the markets in January, leading to what is called the January effect.
Let’s take a look at how this has played out in past years.
The January Effect
Digging down into the details, I ran performance tests to check the validity of the January effect. The main test was a simple one to determine if the January effect actually happens, or if it is just a myth.
Looking back to 1951 for the S&P 500, and selecting a range from about a month before January 1 to a month after, the results support the existence of the January effect. Take a look:
The orange jagged line in the chart represents the smoothed-out path the S&P 500 has taken since 1951 from December through January. While the index is bouncy in January, it stays in positive territory and finishes the month with a median gain of 1.19%, closing positive 54.5% of the time. I use the median because it gives us the central tendency for the data, lessening the impact of positive and negative outliers.
Nothing too jaw-dropping there, but the January effect is clearly in play with a more than 1% gain in the month.
We can break this down a little further.
Knowing that December was a strong month, up about 3.5%, we can look at how January has done following positive December performances since 1951 — and the data paint an even brighter picture.
Following a positive December, the S&P 500 enjoyed a median gain of 2.19% and was positive 60.42% of the time.
Now that’s an exciting return. In the end, we are left with one simple question: Is the January effect worth investing in?
Ringing in the New Year Right
My answer is clearly yes.
The reality is that no one knows whether or not a certain month will be positive until after the fact. What I can say is that, much like a spike in gym memberships every new year, investors have cash to pour into stocks, creating a phenomenon almost as common every new year — the January effect.
With returns coming in at more than 2% in just one month, and odds of it being a positive month at 60%, this is one investment theory that’s worth putting my money behind.
The easiest way to play it is to trade the S&P 500 by buying the SPDR S&P 500 ETF (NYSE Arca: SPY) today and holding it through January. At that point, it will be a good time to re-evaluate how Trump’s agenda is portrayed after his inauguration on January 20.
Until then, we will ride the January effect to capitalize on these short-term gains.
Editor, Pure Income