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GAUGING THE JANUARY EFFECT

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Happy New Year!!!  Here's to good health and good fortune in 2013!
 
Now is the time when market pundits give their predictions for the stock market for the upcoming year.  While it might be entertaining to try to figure out where the S&P 500 might finish in 2013, one of the best predictors of yearly stock market performance lies within January performance.  You wouldn't think that how the market performs in January could have a strong influence on what will happen the next 11 months, but history says it makes a HUGE difference.
 
Let's take a look at this "January Effect".  The basic premise of the January Effect is that "as goes January, so goes the rest of the year".  The numbers bear this out.
 
First, consider that the average annual return of the S&P 500 since 1950 is 8.71%.  Of the 63 years on the S&P 500 since 1950, 35 years have produced annual gains ABOVE 8.71% and 28 years have produced results that are below that 8.71% threshold.  Of the 35 "better than average" years, January was higher in 31 of those years.  By contrast, during the 28 "worse than average" years, the S&P 500 climbed only 8 of those years.  That's a pretty strong correlation between January strength and annual strength.
 
Now let's look at it from a slightly different angle.  Does January strength portend strength the balance of the year?  In the above paragraph, I broke down the results by "better than average" and "worse than average" annual performance of the S&P 500.  In this second approach, I will break down January performance into four quadrants - the top 25% of Januarys, the second 25% of Januarys, etc.
 
In Quadrant 1, the best 16 Januarys in terms of S&P 500 performance produced January gains ranging from 4.10% (1999) to 13.18% (1987).  These MONSTER Januarys averaged rising 6.92%.  Of these 16 years, the balance of the year produced gains in 15 of the 16 years.  In 13 of these 16 years, the S&P 500 rose more than 10% during the balance of the year (not including the January gain).  The average "balance of the year" returns were 17.07%.  So think about that for a second.  The years that produce the best Januarys go on to post ADDITIONAL gains that average 17.07% per year.  The average annual return during these strong January years is an astounding 23.99%.  Not too shabby.
 
In Quadrant 2, the next best 16 Januarys in terms of S&P 500 performance produced January gains ranging from 1.73% to 4.05%.  These 16 years also showed continuing strength over the balance of these years, averaging 9.73% gains over the balance of the year.  13 of these 16 years saw gains during the last 11 months of the year.  The average gain during the balance of the year is 9.73%, significantly below the 17.07% of Quadrant 1, but still very solid action.  The average annual return for Quadrant 2 is 12.62%, again a far cry from Quadrant 1's 23.99%, but still 4 percentage points above the S&P 500's average annual gain of 8.71%.
 
Quadrants 1 and 2 demonstrate the overall positive impact that strong Januarys have on how the S&P 500 trades during the balance of the year.  Januarys that fall in the top half of all Januarys have produced POSITIVE balance of year returns in 28 of 32 years.
 
As you might imagine, this is where the bullish part of the discussion ends.
 
Quadrant 3 January performance averages -0.45% and ranges from -2.53% to 1.56%.  The average balance of the year returns for this group of Januarys is 0.09% with nearly half of these years producing losses from January 31 to December 31.  The average annual return on the S&P 500 for Quadrant 3 years is -0.36%
 
Quadrant 4 covers the worst 25% of Januarys since 1950.  This covers January returns that range from -8.57% to -2.74%.  The average annual returns of the S&P 500 for Quadrant 4 years is -2.10%.  Of the 11 worst S&P 500 years since 1950, 5 of them are situated in Quadrant 4 and 5 more are included in Quadrant 3.  There is obviously a tight correlation between awful stock market years and poor January performance.
 
So while it's entertaining in early January to talk about where the S&P 500 might finish 2013, I'd suggest you wait until January 31st.  You'll have a much better idea then.  January 2013 got off to a great start - now we'll see if the bulls can extend the gains over the balance of the month.
 
Happy trading!
 
Thomas J. Bowley
Chief Market Strategist
Invested Central
http://www.investedcentral.com/

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Tom Bowley
About the author: co-founded Invested Central in 2004 and served as the site's Chief Market Strategist for more than 10 years. Invested Central provides stock market education and guidance for those interested in making their own financial decisions. During his tenure at Invested Central, Tom co-hosted Market Open LIVE, a national radio broadcast that covered many of the largest markets across the U.S. Learn More
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