The January effect

Well that’s January out of the way. And good riddance too. Why people should think that this is the time of year to deny themselves the solace of good food and drink is beyond me. On our wet and cold rock in the North Atlantic, the first month of the year should be about finding comfort and reassurance where we can.

Perhaps that is why investors have latched onto the old adage that a good January in the market means the rest of the year will be profitable too. There are other seasonal sayings about investment - Sell in May, of course, not to mention the superstitious belief that September and October are the most dangerous months in the market - but January is I think the only month assumed to have predictive powers.

If it does then we should enter February in good cheer. According to Bank of America Merrill Lynch, last month was the best January for global shares since MSCI started tracking them in 1988. Its All Country World index rose by 7.8pc in the month, with the US and emerging markets doing even better than the global average.

There are actually two different beliefs about January. The first is what is known as the ‘January Effect’. It combines a few different features of mid-winter markets. First, the fact that many shares tend to perform quite well in January; second, that last year’s underperformers often bounce back in the first month; and third, that smaller stocks outperform in the New Year.

As stock markets are dominated by what happens on Wall Street, the assumed reasons for these effects hold more water in America than here. These include money being paid into 401(k) pension plans in January and a bounce back from year-end window-dressing to polish up fund managers’ performance figures (dogs get sold in December to keep them out of year-end reports).

The more measurable adage is the ‘January Barometer’, which asserts that ‘as January goes, so does the year’. The thinking here is that if the market rises in January investors can expect it to carry on doing so from February to December and vice versa. This is an easier saying to investigate because the performance of shares in the first month and the subsequent 11 is a matter of fact. Whatever interpretation you put on the numbers, they don’t lie.

The bare statistics are initially persuasive but they don’t stand up to much scrutiny. In a study of the S&P 500 from 1950 to 2018, the January barometer was right 68pc of the time. Not bad you might think until you realise that a naïve bet that the market would rise between February and December was right in this period 78pc of the time. Markets rise after a strong January, but they do so after bad ones too.

I have conducted similar research in the UK, looking at the performance of the FTSE 100 since it was launched in 1984. Our blue-chip index has been going for 35 years now, so the data is becoming more statistically significant. Again, it suggests there is next to no usable information to be gleaned from the performance of shares in January.

Between 1984 and 2018, the market rose on 19 occasions in January. Of these, the index continued to rise 15 times. In just four years did the market disappoint in the following 11 months, reversing its early gain to end the year lower on New Year’s Eve than at the end of January. These, for the record, were 1987, 1994, 2001 and 2015 - all difficult years for investors. So again, initially persuasive.

While that sounds like an impressive hit rate, however, it seems less so when you look at the years in which the market fell in January. There were 16 of these in the period under review and in these years the January Barometer worked just six times and failed in ten years. Last year, incidentally was one of the years in which the adage delivered - despite a storming first few days, January 2018 saw the FTSE 100 fall by 2.0pc and it went on to fall by a further 10.7pc between February and December.

Another reason not to worry too much about the direction of markets in January is the fact that the choice of the first month of the year is arbitrary.  Mark Hulbert, a statistician who has run the numbers for every month of the year, says that January is a worse guide to the following 11 months’ performance than April, and only neck and neck with June and November.

So, the bottom line seems to be that most of the time the market rises. Ahead of time you may not know with any certainty what it will do over the following year or so but hold on for long enough and the averages will work in your favour. This is true whether you look at a calendar year or a 12-month period starting at any other point of the year.

What might be interesting would be to overlay the performance data since 1984 with the valuation of the market at the beginning of each year. This is the key determinant of future performance. It is probably why, for example, a weak start to 2003 did not result in a poor year as a whole. After three years of falling markets since the bubble burst, the fall in January was simply the fag end of a bear market which had left markets oversold and cheap. By contrast the fall last January followed two stellar years in 2016 and 2017 which had pushed markets too high.

If you’re looking for some mid-winter cheer, it’s the market’s undemanding valuation at the beginning of 2019, not its performance last month.