January Effect: Fact or fiction?

S&P 500 Seasonality

S&P 500 Seasonality

There is some confusion regarding the term “January Effect” in equity markets. Investopedia defines it as a general increase in stock values in the month of January due to investors getting back into the market after exiting in December for tax purposes.

This appears to have completely disappeared as the performance of the Standard & Poor's 500 Index in the month of January is -1.60 from 2009 through 2014 yet still positive, 0.94, from 1950 to the present. Perhaps the notion of window dressing—where allocators buy successful stocks in December to claim them in their portfolio only to dump them in January—is more common than the old tax trade, which generally is no longer necessary.

Many of us know the “January Effect" — also referred to as the “January Barometer”— as the belief that equity market performance in the month of January will predict how the market will perform throughout the year. If this ever held true — like the other definition of the "January Effect"— it appears to no longer work. It broke down in 2014 as the market made a new all-time high a few days before year-end after dropping roughly 3.5% in January. It is only batting 500 for the 21st century; worse if you take away the bias of including the January return (see chart below).

The red downward arrows indicate years the market deviated from the so called January Effect. As you can see, in the last 14 years the January Effect only held true half of the time; including some big time misses like in 2009 and 2010 when the S&Ps dropped in January before significant up moves. 

The charts below shows a more detailed picture. The first candle after vertical line indicates what the market did in January (green higher, red lower). A horizontal line from December close to December close indicates whether the SPX finished the year up or down and is color coded based on whether the January Effect held true. 

We do not know where the S&P 500 will end this January as there is one day of trading left. Although a negative January appears to be in the cards, we have already seen four significant reversals in trend for the month so it is possible for the market to post a net gain. The S&P 500 would need to rally more than 34 handles on Friday to end the month positive.

Perhaps we can add another theory for the January Effect regarding volatility. If the market performance for 2015 mirrors the January performance, better load up on antacids as it will be a bumpy ride.

Here is a more detailed look at how hte maket performed in Janaury and for the year starting in 2001. 

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