The Capitalist Investor - Episode 58

What is the January Effect? People are so hung up on what happens in the stock market in January. There are so many sayings and hypotheses. Are any of them true? In this episode of The Capitalist Investor, we debate this highly-contested and long-standing wives’ tale. We walk through calendar effects, market anomalies as a whole, and why we should only look at returns in the modern era.

Outline of This Episode

  • [1:40] “As goes January, goes the year.”
  • [5:06] Is history really on its side?
  • [7:00] The game is constantly changing
  • [12:53] Do we buy into the hype?
  • [15:52] It’s just another data point
  • [16:43] A friendly bet to launch 2021

“As goes January, goes the year.”

The belief is that if January is positive, the rest of the year will be positive. Some people believe it’s because the general market sells their losers in December to take advantage of tax-loss harvesting and rebuy them in January. They believe the money flowing back in helps prop the stock market up. But people sold their winners in January 2021. So that can’t be it, right?

Is history really on its side?

Since 1950, the S&P 500 has been up around 74% of the time. Also since 1950, the S&P 500 has been positive 62% in January. If January goes up, then the year finishes positive 87% of the time. It’s only been negative 17 of the last 73 years.

I looked at monthly returns from 1950–2020 to get the data. What I found is the best performing month is April (then November, December, July, then January). It’s the 5th best performing month, but people are so hung up on the January Effect.

But what happens when you change the timeline? Derek’s research shows that the average return for January is positive at 1.8%. The average for other months combined is only positive 0.7%—going back to 1928.

From my perspective, January just happens to be part of a great stretch. The market is seasonally strong from November through May. The market is sleepy in the summer-time and early fall. I would bet 70–80% of the market’s returns come in those months.

The game is constantly changing

Should we look at anything before WWII? What about before the internet existed? The game has changed and we’re entering this period of modern monetary theory. When you can’t manipulate interest rates anymore you resort to creating money.

I read the book Unknown Market Wizards. It’s about individual traders that took $100,000 and turned it into 10+ million dollars. They all got lucky. Secondly, every single one had a trading system that worked—but it eventually went obsolete. It goes to show that the game changes.

Things are so vastly different now. So maybe we do only need to track the modern era. History may not repeat itself, but it tends to rhyme. Anything pre-2000 is just not relevant.

Do we buy into the hype?

Before 2020, the most distressed the market had been in recent years was from October to Christmas in 2018. That quarter was down around 8–9%. It was magically up 8–9% in January 2019. The momentum carried forward. It has to do more with momentum and whatever’s leftover from the year before.

It could be investor psychology, too. Maybe people made a resolution to save more money or buy more stocks. But do the retail investors investing an extra $100 a month really move the market? No, they don’t. Institutions reallocating money moves the market.

What do we think it really is? Is it just another data point? Listen to the whole episode for our take—and a friendly bet to launch 2021.

Resources & People Mentioned

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