Personal Investing
Tom Stevenson 10 Jan 2018 09:39am

What the January effect really tells us

Investors love seasonal adages. Sell in May, the Santa Rally and, at this time of year, the January Effect

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Caption: Some believe January investments predict the year's outcome
Opinion is divided on whether these have any value. Sometimes they work, sometimes they don’t. Even when they work on average over time, investors don’t necessarily have the discipline to stick with them through the inevitable periods when they don’t deliver.

It’s wrong to dismiss these sayings completely, however. There is a reason why they have stuck. Perhaps the lessons we can learn from them are not what they seem at first glance, though.

There are several versions of the January Effect. One says that just the first day of the year sets the tone for the year as a whole. Another looks at the first five days’ trading. The one I have analysed for a few years now is the one that says ‘as January goes, so goes the year’.

In other words, if January is a positive month then so too will be the period from February to December. Likewise, if the market falls in January the odds are that February to December will also be disappointing.

To test the adage, I have tracked the FTSE 100 since it was launched in January 1984. That’s a full 34 years now so it’s starting to be a meaningful period to analyse.

The good news is that over this period, the UK benchmark has risen in January on 19 occasions, slightly more than 50% of the time. The better news is that in 15 of these years, the market has gone on to rise further between February and December.

On the face of it, a rising January market has indicated a buying opportunity 80% of the time. That looks to be more than chance.

The trouble with this analysis is that it only looks at half the story. It’s a classic case of confirmation bias - looking for the data that supports the case you are trying to make.

If the January Effect were to be a really useful signal it would also indicate poor years ahead. If the market fell in January you would expect the rest of the year to be poor more often than not.

Unfortunately, that is not the case. In the 15 years in which the market has fallen in January, it has gone on to rise from February to December on 10 occasions. A weak January only signals a fall in the rest of the year, one time in three.

So, what is the real message from the January Effect? There are two lessons for me. First, a rising January market is a good signal of a positive year ahead but only because in a bull market momentum is a powerful force. One good month is very likely to be followed by other good ones.

Second, the tendency for bad Januaries to be followed by positive gains in the rest of the year is simply a reflection of the fact that over the past 34 years the trend of the market has generally been upward. Betting against a positive return in any one year is to bet against the averages.

This is an important lesson for investors. It suggests that the odds are stacked in favour of investors who stay fully invested and see out the inevitable ups and downs of the market. No-one can predict the future with any certainty but the best way to navigate that uncertainty is to be well-diversified rather than to try and catch the big turning points in the market.

Of course, that does not mean that investors should not be consistently optimistic throughout the market cycle. The odds of a rise or fall in the market clearly change in light of how long shares have already been rising or falling and how high or low average valuations are.

Investors can adjust their portfolios on the basis of these variables, becoming more or less aggressive or defensive according to the market backdrop.

Every quarter I write my Investment Outlook to try and help Fidelity investors with those decisions and the next issue of my Outlook is now available to watch on demand.

By Tom Stevenson, Fidelity Personal Investing

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