Tomorrow will be the last trading day (LTD) of January.
As explained in the 2014 edition of the Almanac the LTDs of months used to be stronger than average, but in recent years they have been weak.This can clearly be seen in the case of January from the chart below. From 1984 to 1999 the FTSE 100 only fell twice on the last trading of January. But since year 2000 the market fallen more often than risen on this day.
Since 1984 the market has on average risen 0.19% on the LTD of January, with positive returns in 62% of all years, which makes the January LTD the third strongest month LTD in the year. However, as indicated above, things have changed since 2000: the average LTD return in January has been -0.17% making it the third weakest month LTD in the year.
The following chart shows the FTSE 100 Index returns for every January LTD since 1984.
It would seem that the dot-com crash in 2000 had a big effect on the performance of the stock market in the month of January. Up to that point, January had been one of the strongest months of the year for the market, but now it is ranked ninth of all the months. This can be seen in the chart above: in the years 1982-1999 the market only fell in January twice, but in the 14 years since then the market has only risen this month in 5 years. So, if taking history as a guide for the performance of the market in January it is necessary to decide whether to look at the short or longer-term
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.
Small caps like January
Mid-cap and small-cap stocks tend to out-perform large cap stocks in this month (called the January Effect). On average, since 2000 the FTSE 250 Index has outperformed the FTSE 100 by 2.3 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 3.7 percentage points in the first month.
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 we’ve seen above, that has been less true in recent years. (More detail on January effects.)
In the last twenty years the sectors that have been strong in December have been: Construction & Materials, Financial Services, and Media; while the weak sectors have been: Beverages, Food & Drug Retailers, and Food Producers.
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%
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.
A previous post looked at the average FTSE 100 returns on the first five trading years of the year.
The following chart reproduces the chart from that post – showing the average FTSE 100 returns for the first five trading days of the years 1985-2012. The second chart shows the returns for the first five trading days of 2013.
As can be seen, the profile of returns is similar: the first day being the strongest, with returns trailing off after that, and with the 4th and 5th days having negative returns.
January is a middling month for the stock market. Since 1984 the market has risen in 57% of all years in January, with an average rise of 0.3%. This makes the month eighth in the ranking of monthly performance. Interestingly, it is the month whose performance has changed the most over the last few years – in 2007 the month ranked fourth and has since fallen four places.
The accompanying chart plots the average day-by-day performance of the FTSE 100 Index throughout January since 1985.
As can be seen, historically the euphoria of December (the strongest month of the year) 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. In fact, 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, and rises to end the month slightly up.
January is part of the strong six months of the year (November-April, the Sell in May effect), but it is the weakest month in this period.
The month is better for mid-cap and small-cap stocks. On average, the FTSE 250 Index outperforms the FTSE 100 by 1.6 percentage points in January – the best out-performance (with February) of all months. Small caps do even better, out-performing the FTSE 100 Index by on average 3.7 percentage points in the first month.
A famous market predictor in the US has it 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.
Anniversaries for the month are: 18 January will be the 40th anniversary for both Bodycote and Halma who listed on the LSE in 1972, while 29 January will see respectively the 50th and 60th anniversaries of British American Tobacco and Monks Investment Trust listing on the LSE.
Dates for the month: 1 January – the LSE closed, 3 January – MPC interest rate announcement at 12 noon, 20 January – inauguration of new (old) US president, 21 January – US market closed (Martin Luther King Day).
Since 1985 the FTSE 100 Index has increased on average 0.45% over the first five trading days of the new year.
The following chart shows the first five days percentage change for all years from 1985. For example, over the first five days of 1985 the index rose 0.89%.
The following chart shows the average percentage FTSE 100 Index move for each of the five days in the new year. For example, on average since 1985 the index has risen 0.37% on the first trading day of the year.