Looking For The January Effect

Includes: DIA, QQQ, SPY
by: James Picerno

This article has been updated, see below.

Once upon a time investors believed in the January effect. The story is that there's gold in them 'thar hills for equity returns during the first month of the year. The idea that January dispenses richer results than the other months dates to economist Sidney Wachtel's 1942 study on seasonality effects in the market. It's been a winning idea ever since, judging by all the attention it receives. As an investment concept, however, it looks distinctly unimpressive, or so recent history suggests.

The average return in January for the S&P 500 since 1991 is 6.7%. Not too shabby, you say? Well, seven other months of the year provided stronger results over that two-decade stretch. April was unusually strong with average returns in excess of 40%.

If we restrict our analysis to the last 10 years, the January effect slips into negative territory, with the month posting an average decline of just over 16%. Once again, April is the leader for the 2001-2010 period, boasting a 27.1% average gain. April, of course, is the dreaded month when taxes are due—is there an IRS effect? Intrepid researchers will want to jump on this one—heck, it seems we're in need of a new calendar-based anomaly.

Indeed, the January effect seems to have lost its shine. Or has it? SmartMoney ventures a guess as to "What a January Jump Says About 2012" while Mark Hulbert advises that "only the smallest stocks tend to shine in January." Another analyst confidently asserts that "the January effect is in play" in the wake of yesterday's pop in the first trading session of the new year.

Maybe, although the record looks conspicuously unappealing for expecting much more than random results in January. That doesn't mean this month won't deliver stellar results, but ascribing it to a systematic calendar effect may be pushing your luck. Then again, there are mitigating circumstances these days, we're told. The January effect is "less sure because of nervousness," according to one news story. Even anomalies need a vacation at times. Trying to live up to elevated expectations is exhausting work.

Update (and mea culpa): Debunking this idea still looks good based on the past 10 or 20 years, but it turns out that the numbers are even worse than I initially reported. In the above post I mistakenly reported the sum of monthly returns for each monthly period—my apologies to readers. After correcting the error by computing the standard average of monthly returns (see the new chart below), I find that the January effect is even more elusive.

Here’s the updated chart showing the true average returns for the respective months over the trailing 10- and 20-year periods. There may be a January effect, but it’s not necessarily the one you’ve been expecting.

Some analysts say that the true value of the January effect is that it sets the tone for the year-ahead performance in the stock market. That argument is on stronger statistical ground, although it’s hardly a slam dunk. Details to follow shortly....