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January 4, 2017

When Reality Bites with the 'January Effect'

By Wolf Richter, Wolf Street

A myth gets destroyed by facts.

We’re going to read about the “January Effect” on a daily basis for the next few weeks. It’s the time of the year when the stock market in the US rises because it’s January. It’s a great time to buy, the hypothesis goes. It has been around for decades and resurfaces every January.

It’s based on the idea that there are some powerful seasonal anomalies that cause stocks to rise in January. These are among the most often touted reasons:

  • Tax selling by investors in late December to “harvest” losses they had on some stocks to offset capital gains they’d realized on other stocks. This common tax strategy, according to the “January effect” hypothesis, leads to more emphatic buying in January, big enough to move the needle. 
  • Bonus time, when sudden piles of money in the hands of individual investors begin percolating through the economy, and the first thing the lucky ones buy is stocks, so the theory.  
  • Psychology, as investors, based on a new year’s resolution or whatever, decide to finally be smart about money, etc. and buy stocks.  
  • The “January effect” itself, as investors start acting on it and buying stocks partly into the month, assuming it is touted enough in the media.

The theory is based on the notion that the stock market is inefficient. All calendar-based stock predictions are based on it. And markets are inefficient. They’re manipulated by central banks, governments, and the financial industry in myriad ways. But they don’t care about January.

If the “January Effect” really were so predictable, wouldn’t market participants prepare for it by front-running it and buying ahead of time in order to benefit from it? Alas, if everyone buys ahead of time to realized the gains at the end of January, wouldn’t that eliminate from the outset the effectiveness of the entire “January Effect?”

Yep. It sure would. And it does. Or something does. Because… since 2006, the “January Effect” produced positive results in five Januaries and negative results in six Januaries:


So these past eleven years show that currently the “January Effect” – no matter what it was in the 1960s or 1970s – is more or less a random occurrence and of zero help to investors. It means if you bet on the “January Effect,” you have to be lucky make money.

The “January Effect” has a second meaning, the “January barometer,” a theory that says the performance of the stock market in January reflects its performance for the rest of the year: “As goes January, so goes the year.”

The chart above shows that if this happens, it is also just luck. Over the past 11 years, there were six Januaries when the S&P 500 slid, and in some cases steeply. But in four of those six years, the S&P 500 ended up rallying for the year:

  • 2009: +23.5%  
  • 2010: +12.8%  
  • 2014: +11.4%  
  • 2016: +9.5%

Of the six years when the S&P 500 dropped in January, it predicted the rest of the year correctly only twice: in 2008 (-38.5%) and in 2015 (-0.7%).

However, of the five Januaries when the S&P 500 was positive, the entire year ended up positive. So can that predictive quality – if January is up, the year will be up – be relied on?

It just so happens that over the past 14 years, thanks to massive central bank intervention, the S&P 500 ended the year in the red only twice (2008 and 2015), or rather, just once (2008) because in 2015, the loss was only -0.7%, and dividends turned the whole year in terms of total return into a gain of +1.4%.

That’s why most of Wall Street always predicts that stocks will always go up. More often than not they do. And so that prediction will be correct much more often than not. And if stocks crash, central banks soon flood the land with cheap credit and QE so that they do go up.

This has worked to the point where the distortions have now reached dizzying levels. So central bank actions, particularly QE, have been far more accurate than the utterly useless “January Effect” in predicting annual stock market returns because they actually attempt via the magnificent power of the printing press to inflate asset prices. But even those efforts have become less accurate predictors recently, as seen in the EU and Japan, where more and more QE and negative-interest-rate absurdities accomplish less and less.

Courtesy of Wolf Richter, Wolf Street

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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Item Reviewed: When Reality Bites with the 'January Effect' Rating: 5 Reviewed By: Econ Matters