How Reliable Is the January Effect?

January came in with whimper with all major indices falling across the board. The DJI did the best falling -3.5% whilst the Shanghai Composite fell -8.8%. If you want to take the glass is half full view, 2010 was the best January for the S&P500 in the last 3 years. January 2008 saw a -6.1% slide in the S&P500 whilst in 2009 the S&P500 fell -8.6% as shown below.

Of course this time of year brings out the old adage, as goes January so goes the year, meaning that if the stock market is down in January it will be down for the year and vice versa. But just how accurate is the so-called January effect? After all, January 2008 was down and so was the year, however if you invested on that basis in 2009 you would have missed a year of stellar returns in the stock market.

Taking a look at the S&P500 over the last 60 years, the January effect seems to have some predictive value although that comes with some caveats. As shown in the table below, over the last 60 years the S&P500 has finished higher in January 37 times and subsequently the S&P500 finished the year higher 34 times. Or said another way 92% of the time January has finished higher the year has also finished higher. However when the S&P500 has finished down in January the year has only finished down 57% of the time or 13 times out of 23 in the last 60 years.

The results are not unexpected since as we know over the last 60 years, the S&P500 has risen on an annual basis

73%

of the time or 44 times out of 60. So of course the January effect has better predictive ability when the S&P500 finishes higher. However since January 2010 was a down year you might as well flip a coin as rely on the January effect for guidance on how the year will end.