The Bogus January Effect
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The "January Effect" – a belief that what stocks do in January signals what they will do for the year – has many bears and short-sellers giddy these days.  At the same time, some investors are running scared.  After all, the S&P 500 was down a "whopping" 3.6% last month (January 2014).

We would call the January Effect "technical analysis," because there is no known economic or fundamental reason for a one-month change in any price (even if it is the first month of the year) to signal the next eleven months direction.  Markets move up and down on a month-to-month basis all the time.

However, fiscal policies often have a start date of January 1st and it could very well be that changes in policy that occur on the first of the year have an impact on the first month, and every month, of a given year.  Or, it could be that something changed in the previous year and the momentum of that change affects January and the year in full.

So, with all this in mind, we went back and looked at the 13 previous times since 1978 that January saw a decline in the S&P 500.  Of those 13 years, only five saw a full year decline in stock prices.  And, each of those five years of decline had something way bigger than the January Effect happening.  In 2008, it was a panic (caused by mark-to-market accounting).  In 2002, we were still falling from the tech bubble, the 9/11 attacks and delayed tax cuts from the Bush White House.  In 2000, the market was overvalued from the tech bubble and Fed created deflationary pressures.  In 1990, the US was in recession and Iraq invaded Kuwait.  In 1981, a nasty Paul Volcker interest rate hike recession was underway. 

The other eight years, since 1978, that had a down January ended up having positive moves in the stock market for the full year.  In other words, the January Effect doesn't work very well and when it does, we can argue that it had nothing to do with January itself.

In 2014, the economy continues to grow, and may be accelerating, companies are more profitable than ever, have more cash than ever, and are more productive than ever.  Housing is still in the early stages of a recovery, and consumers' financial obligations are hovering at the smallest share of income since the early 1980s.  (Financial obligations are money used to pay mortgages, rent, car loans/leases, as well as debt service on credit cards and other loans).

Meanwhile, technologies like fracking, the cloud, tablets, smartphones, apps, biotechnology, and 3D printing, to name just a few, are boosting efficiency and profitability. To top it off, in spite of the rollout of Obamacare, government spending continues to shrink as a share of the economy leaving more room for the private sector. We believe the upside risk for stocks is far greater than the downside risk, our models say stocks are cheap, and we look at January as just another month of volatility, not a prescient harbinger of the future.  We still expect robust stock price gains in 2014.
Posted on Tuesday, February 4, 2014 @ 1:47 PM

These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.