Does the Calendar Matter? The Seasonal January Effect

Taken from iSharesblog.com

Investors will look anywhere for an edge. I have had otherwise rational and smart traders make impassioned arguments on the significance of Fibonacci sequences, sun spots, pi, and in one memorable case the Book of Revelations. Given the human propensity to find patterns everywhere, it is not surprising that people will turn to any data that seems to offer even a glimmer of an insight into financial markets. In that spirit, it is not surprising that a fair amount of ink is typically spilled this time of year in an attempt to link the calendar to market performance. Is market seasonality any more meaningful than the musings of 12^th century Italian mathematicians?

The biggest problem with seasonality studies is simply the lack of data. Even for US large caps, with only around 100 years of accurate data investors have a relatively limited number of observations from which to draw any conclusions. An even bigger challenge is that markets, unlike physical phenomenon are not stable. When too many people become aware of a market pattern it quickly evaporates as investors trade ahead of the data. Finally, and perhaps most dangerous, gathering and analyzing data has become so easy that any data set lends itself to drawing some conclusion if you look hard enough.

Take for example the conventional lore that US equity markets do best in January. Investors can find ample evidence to support or refute the idea depending upon where and when they want to look. A cursory study of the S&P 500 can support the notion that January is the best month of the year. Since 1928 the median monthly return on the S&P 500 has been 1.54%*, nominally ahead of December and technically the best month of the year. However, this conclusion comes with several caveats.

First, there is no statistical difference between January’s returns and July and December’s.

Second, if you look at average returns, which will be more influenced by extreme months, rather than median returns the answer changes. Based on average returns January is actually the forth best month of the year behind July, December, and even April.

Third, to the extent any given market statistic becomes well socialized its significance is sure to dissipate. If you look at the more recent past, January’s unique position starts to fade.

Since the late 1980’s, the average return in January has dropped from around 1.50% (1928 to 1987) to roughly half of that level, 0.81%. This actually places January in the lower half of months. What appears to have happened is that as investors became more aware of a mild seasonal bias, they bid the market up in anticipation of the January rally, and in due course the seasonal effect shifted from January to December.  This illustrates perhaps the most important lesson in market anomalies; even for the ones that have some validity, they generally come with an expiration date.

Sources: Bloomberg, Barrons, Reuters

*Returns based on Bloomberg data and are net of dividends. Index returns are for illustrative purposes only and do not represent actual iShares Fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.


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