Weekly outlook

As January goes so goes the year

By Tom Stevenson, 7 January 2009

No-one is quite sure why, but one of the most reliable indicators of the stock market year ahead is how shares trade in January Illogical as it may seem, the seasons matter to stock market investors. The old advice to Sell in May and Go Away appears to contain more than a grain of truth and October is notoriously the month for market crashes. Equally inexplicable is the apparent tendency for January to be an indicator of the market performance for the year as a whole: As January goes, so goes the year.   A couple of years ago some American academics put the theory to the test and discovered that when the S&P 500 index rose in the first month of the year it went on to rise an average 14.8% during the remaining 11 months. If shares fell in January, by contrast, stocks rose on average by just 2.9% in the rest of the year.

"If January is noticeably bad, be fearful" Tom Stevenson

The research (published in the Journal of Financial Economics in November 2006) showed that shares rose in 41 of the 64 Januaries between 1940 and 2003. In fully 36 of these strong starts to the year, the following 11 months were also positive – an 88% hit rate.

The effect is less powerful when shares fall in January but the odds are still in your favour. In the 23 down years covered by the study, shares continued to fall for the rest of the year on 14 occasions.

One of the most striking examples of this occurred last year when the 6.1% fall in the S&P 500 in January set the tone for the difficult year ahead.

Recent studies suggest that the January effect is less prevalent outside the US. This may have something to do with the apparent link between stock market returns and the Presidential election cycle, although the evidence is not really compelling.

One piece of research by the Investors Chronicle magazine showed that a January rise led to a rise in the following 11 months 72% of the time in the UK, a bit less convincing than the American survey, especially when you consider that shares rose two thirds of the time whatever happened in January.

More convincing is some work done by stock market historian David Schwartz who has focused on the years when, like last year, the market has fallen sharply in January. He found that in the 11 years in the last 90 when the UK market fell by more than 3.1% in January it went on to fall in the subsequent 11 months on seven occasions and was flat twice.

The fall in 2008 might have been at least a warning flag that the rest of the year would be tough, even if no-one would have been well-advised to rely on this indication in isolation.

The table below shows the performance of the UK stock market in the last 25 Januaries together with the full year outcome in each case. It’s a bit of a mixed bag, but over this shorter time scale, our data would seem to confirm David Schwartz’s theory that significant moves have the best predictive power.

 

Shares have fallen in January in 8 out of the past 25 years, according to Datastream. Only half of these indicated a subsequent full year decline but three out of four of the bigger falls of 3% or more did. The message seems to be: if January is noticeably bad, be fearful.

Equally, if January is a good month, recording a gain of more than 3%, then the odds are firmly in favour of the full year turning out well. On the eight occasions this has happened in the past quarter century, shares have fallen in the year as a whole just once.

The average gain in the years that began with a January rise of at least 3% has been 13%.

No one is going to base a long-run savings and investment strategy on such flaky evidence but, unlike the “finger in the air” predictions that fill the papers at this time of year, this interesting little quirk at least seems to have some statistical substance.