The January Effect Revisited

In our last market update, we talked about “the January effect”, a phenomena in which a positive market in January has a high correlation to a positive market for the entire year. Below is a copy of that e-mail:

“The January Effect

This is an anomaly where the stock market rises during the first week of January. The explanation to why this occurs is that those investors that sold off in late December to capture gains/losses in their portfolio reinvest those assets back into the market at the beginning of the following year. The anomaly occurred again this year with the Dow rising +1.8% and the S&P 500 rising +2.7% during the first trading week of 2010.

The first week anomaly is interesting; however, what is more important is how the stock market performs for the whole month of January. Positive January market performance sets the stage for the entire year. Since 1950, there has been only two years (1966 and 2001) when the stock market (S&P 500) was up in January and ended down for the year. If the market remains positive for the month of January, the odds are in favor that the market will perform well in 2010.”

What happens when January is Negative?

Many stock market indicators are good barometers in one direction, but not in the other. For example, having a large percentage of insiders buying their own company stock is almost always a very good signal to buy that stock. Why? “Insiders” typically are privy to information about the future prospects of their own company that is not widely known and if they are willing to put their money into buying shares, then this may be a good indication to an “outsider” to invest in the same company. Many investors automatically believe insider selling is bad for a company. This is not necessarily true. Many times, insiders sell for other reasons (portfolio diversification, planned sales, tuition payments, new purchases, etc.) than just the share price. Insiders buy for one reason – they believe the stock is undervalued where as there could be a host of reasons for selling. That is why insider buying is a better indicator than insider selling. The same thing occurs with the January Effect.

The January Effect works over 90% of the time (these are very good odds and better than any you could get in Las Vegas). The question is: does it also work in reverse when stocks fall in January? The answer is no. Since 1950, the stock market has produced negative returns for the month of January a total of 23 times. Of those 23 negative January months, stocks were lower in 12 of those years and positive in 11. In other words, there is only a 52% (12/23) chance that the market will be negative at year end because stocks were negative in January. Statistically, this is not a good indicator to tell you how stocks will perform for the whole year. It truly is a coin flip on whether they will be positive or negative. A perfect example is 2009. The S&P 500 was down -8.43% in January and ended the year up 26.5%. Those that sold off in February because stocks were negative in January missed a significant money-making opportunity the remainder of the year.

Sincerely,

Your THOR Team