Generally, January is a very good month for investors. A recent academic paper (Vichet Sum, 2013) found that January has the second strongest average monthly returns for 70 world markets, and has been the strongest month of the year for 16 of those markets.
However, this is no longer the case in the UK. Although January used to the strongest month of the year for the UK stock market (with an average month return of 4.5% for the period 1970-1999), this changed after the dot-com crash. Since 2000 the average month’s return has fallen to -1.8% and the market has risen in this month in only five years since 2000 – making January the weakest month of the year in the last few years.
January follows the strongest two-week period of the year (the second half of December); and this exuberance traditionally carries over into the first few days of January as the market continues to climb for the first couple of days. But by around the fourth trading day the exhilaration is wearing off and the market then falls for the next two weeks – the second week of January has been the weakest week for the market in the whole year. Then, around the middle of the third week, the market has tended to rebound sharply.
The month is better for mid-cap and small-cap stocks. On average, since 2000 the FTSE 250 Index has outperformed the FTSE 100 by 2.2 percentage points in January – the best out-performance (with February) of all months. Small caps do even better, out-performing the FTSE 100 by an average 2.7 percentage points in the first month. The out-performance of small-cap stocks in this month has been the subject of many academic studies and is called the January Effect.
There are two other interesting anomalies in the month (that are also sometimes, and confusingly, called the January Effect). The first is a famous market predictor in the US which holds that the direction of the market in the whole year will be the same as that for the first five days of January. Research shows that the same rule works more or less for the UK market as well. The third effect comes from a U.S. paper written in 1942 which proposed that stocks rose in January as investors began buying again after the year-end tax-induced sell-off. As noted above, that has been less true in recent years.
Article first appeared in Money Observer
Further articles on the market in January.