Results in the 12th and 1st months are just as significant as the other 10.
Having a monkey throwing darts might work as well as using December or January data to predict the following year’s market performance. So many different economic, political, weather, and other factors will pop up at some point throughout the year. Concerns about inflation, interest, tax and more will replace other concerns, and new economic news will gain prominence. However, market performance for the previous year does matter. Investors should not ignore poor market performance for individual stocks or market segments. Furthermore, it is important that investors learn the reasons behind the poor market performance. When predicting market performance for the following year, results in December or January appear to be no more important than results at any other time.
The January Effect
Investment banker Sidney Wachtel first noticed the January Effect in 1942. The theory proposes a pattern in the price of stocks in the last few trading days of December and the first few weeks of January. During this period, particularly starting in January, the theory is that stocks – especially smaller cap stocks – tended to rise. Historical data from 1904 – 1974 discovered that the average return during January was five times larger than in other months. Another study showed that small-cap stocks outperformed large-cap stocks by 0.8% in January but lagged large-caps for the rest of the year. Starting with the year 2000, however, the results have been a mix. In the 23 Januarys since 2000, almost half the time the market lost ground during the month of January.
Reasons for the January Effects
One theory is that the historical January Effect is a consequence of tax-loss selling. This is when investors sell stocks that lost money at the end of December, to take losses as tax deductions. Stocks that lost value sold in late December, were – in theory – available at a discount in early January. Another theory highlighted the payment of year-end employee bonuses, which employees dutifully invested in the stock market. Thus, making the market more active and causing prices to rise. That one sounds suspect.
In recent years, the January Effect has become much less pronounced – to the point of not really existing. The reason is straightforward: once the theory became well known, “smart” investors started buying in December instead of January. In other words, the markets adjusted. In addition, since many investors use tax-sheltered retirement plans, like IRAs and 401(k) plans, there is no reason to sell a stock for the purpose of deducting losses.
The Santa Rally
Back in 1972, Yale Hirsch of the Stock Trader’s Almanac proposed the existence of the Santa Rally. This has been a constant source of eggnog-fueled debate for decades. The Santa Rally refers to the general tendency of the U.S. equity markets to post gains in trading days between Christmas and the first two days after New Year’s. The Stock Trader’s Almanac found that since 1950, the average movement in the S&P 500 Index during this period of seven trading days has been a gain of approximately 1.4%
The December Effect
Since 1950, we have had a lot of Decembers. Did you know that 54 of those Decembers brought positive gains for investors while 18 produced negative returns? Further, the S&P 500 has gained an average of 1.6% during December, the highest average of any month and more than double the 0.7% gain of all months, according to data from Morningstar (September, is the worst month of average for stocks, with a 0.7% average decline).
Monkeys Throwing Darts
If you incorporate the January Effect, the Santa Rally, or the December Effect into your investment theory, then you may also want to make a trip to the zoo. In 1973, Princeton University Professor Burton Malkiel claimed in his best-selling book, A Random Walk Down Wall Street, that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.” And guess what? According to a publication from Research Affiliates, with 100 monkeys throwing darts at the stock pages in a newspaper, the average monkey outperformed the index by an average of 1.7% per year since 1964.
