An Ineffective Indicator: January’s Returns

Well that didn’t take long. After three modest down days to kick off January, headlines are a-tizzy over the January Effect—the long-running myth that January, or its first five trading days, or whatever else people fancy to make things fit, predicts the year’s returns. Even before Thursday’s small rally turned into a small dip, people were fearing Tuesday and Wednesday’s meant this will be a bad year indeed. As with all seasonal saws, we suggest not getting sucked in. No part of January is predictive.

Exhibit 1 shows this the simplest way we know how, tallying the number of times a negative January preceded a negative year or a positive year—and the number of times a positive January started a negative or positive year. As you will see, the most frequent outcome was both January and the full year rising. That happened in 52 of 99 completed years since 1925. But the second most frequent was a negative January feeding into a positive year, which happened 21 times. That is more often than the down January, down year combo, which happened 17 times. If a down January failed to predict the year more often than not, then we fail to see the fortune-telling powers here. About all we can glean is that stocks rise more often than not in both months and calendar years, which we would think is already a pretty darned well-established fact.

Exhibit 1: So Goes January, Whatever

Source: Global Financial Data, Inc., as of 1/4/2024. S&P 500 total returns in January and full calendar years, 1925 – 2023.

We suspect the January Effect is getting so much ink now for two reasons. One, it “worked” in 2022, when the bear market started after the S&P 500 and MSCI World Index peaked on January 3 and 4, respectively—and in 2023, when January and the year were up big. Recency bias makes these data points loom large. Two, January’s early stumble seemingly confirms a lot of the latent negativity simmering among investors, making it tempting to extrapolate. It happened with high-ish price-to-earnings ratios, suggesting to those who read into such things that overvalued stocks were necessarily letting some air out. And it concentrated in several recently high-flying Tech stocks, seemingly confirming all the fears that their big 2023 run was an AI hype-induced sugar high.

But sometimes volatility is just volatility, and normal volatility often pairs with countertrends, where recent leaders get hit hard. That happened during last year’s correction. Large growth stocks led during the rally through July, trailed as markets pulled back, then led again in the sharp bounce to new bull market highs. They won’t always win, and a shift to value later this year wouldn’t shock us. Perhaps overenthusiasm for Tech and growth will feed into that, but there are some other things we would expect to see if a shift were to have legs, including a re-steepened yield curve and a high likelihood of accelerating lending. Instead, we have a more-inverted yield curve (thanks to long rates’ fall since October) and slowing lending, which favors large growth-oriented stocks over value since they can use their size and lovely balance sheets to self-finance growth.

So don’t latch on to any of the reasons you might be seeing for the rocky start and its allegedly predictive powers. It doesn’t mean investors who had free cash from tax-loss harvesting in December are scared of buying. It doesn’t mean fund managers are skittish. It doesn’t mean Tech companies have to put up or shut up—and won’t be able to. Actually, earnings are improving, and with businesses mostly past cutting costs in anticipation of a recession that never came, private investment will probably pick up some, driving future profits. Oh, and this is also an election year, historically bullish for stocks, with S&P 500 returns positive over 80% of the time. We will have a more detailed forecast for you soon, but in the meantime, suffice it to say we think the bull market continues, and sitting on the sidelines because January stumbled out of the gates probably isn’t a wise move.