It’s January, so let’s talk about the January Effect.
But which January Effect would that be?
We’ve come across three different uses of the term. A quick overview follows.
1. Small-caps out-perform large caps in January
The most common use of the term January Effect describes the tendency of small-cap stocks to out-perform large-cap stocks in January.
In 1976 an academic paper found that equally weighted indices of all the stocks on the NYSE had significantly higher returns in January than in the other 11 months during 1904-1974. This indicated that small capitalisation stocks out-performed larger stocks in January. Over the following years many further papers were written confirming this finding. In 2006 a paper tested this effect on data from 1802 and found the effect was consistent up to the present time.
The UK market experiences the same January Effect as seen in the US market. The small cap out-performance in January is significantly strong: the FTSE Small Cap Index has out-performed the FTSE 100 Index by an average 3.7 percentage points in all Januaries since year 2000. And the small cap index has under-performed the FTSE 100 Index in just one year in the past 13.
The following chart shows the average FTSE Small Cap Index out-performace of the FTSE 100 Index for each month since 2000.
2. January predicts the market for rest of the year
Historically, the returns in January have signaled the returns for the rest of the year. If January market returns are positive, then returns for the whole year have tended to be positive (and vice versa).
This is sometimes called the other January effect, or January Predictor or January Barometer and was first mentioned by Yale Hirsch of the Stock Traders Almanac in 1972. A variant of this effect has it that returns for the whole year can be predicted by the direction of the market in just the first five days of the year.
Academic research has largely found that January returns can predict the rest of the year, but there is some doubt as to whether the effect can be exploited.
And Dan Greenhaus of BTIG points out that January is not necessarily any better a predictor of full year performance than any other month. According to him,
When February is down, the 12 month return inclusive of that February is 2.0%. When February is up, the S&P 500 returns 12.53%
and similar for the other months.
3. The market tends to rise in January
In 1942 Sidney B. Wachtel wrote a paper, “Certain Observations on Seasonal Movements in Stock Prices”, in which he proposed that stocks rose in January as investors began buying again after the year-end tax-induced sell-off.
Looking at the returns for the FTSE 100 Index since 1984, it is true that they tend to be positive – but not strongly so. The index has risen in 57% of all Januaries since 1984 with an average increase of 0.3% – which ranks it in eighth place of the 12 months.
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- Rozeff, Michael S. and Kinney, William R. , Capital market seasonality: The case of stock returns (1976)
- Wachtel, Sidney B., Certain observations on seasonal movements in stock prices (1942)
- Bohl, M. T. and C. A. Salm, The other January effect: international evidence (2009)
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- Brown, Lawrence D. and Luo, Liyu, The January Barometer: Further Evidence (2006)
- Brown, Lawrence D. and Luo, Liyu, The Predictive Value of the Signs of January Returns: Evidence of a New January Effect (2004)
- Cooper, Michael J. and McConnell, John J. and Ovtchinnikov, Alexei V., What’s the Best Way to Trade Using the January Barometer? (2010)
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- Easterday, Kathryn E. and Sen, Pradyot K. and Stephan, Jens, The Persistence of the Small Firm/January Effect: Is it Consistent With Investors’ Learning and Arbitrage Efforts? (2008)
- Easton, Stephen A. and Pinder, Sean. M., A refutation of the existence of the other January effect (2007)
- Ghosh, S., G. Bhalla, and W. T. Ziemba, The January barometer, 1926-2005 (2007)
- Guler, Sevinc, January effect in stock returns: evidence from emerging markets (2013)
- Lit, Ho-man Vienna, The January effect revisited : evidence around the world (2007)
- Marshall, Ben R. and Visaltanachoti, Nuttawat, How Accurate is the January Barometer? (2008)
- Marshalla, Ben R. and Visaltanachoti, Nuttawat , The Other January Effect: Evidence against market efficiency? (2010)