As we turn the corner on a New Year, the conversation often turns to the “January Effect”: the theory that the stock market has a tendency to post a gain right at the beginning of the year.
The January Effect is an observable phenomenon. Since the late 1800’s, the Dow Jones Industrial Average has risen in January 63% of the time. For all the other months of the year, it has gained 57% of the time (MarketWatch). The same goes for the S&P 500: since 1964, the index has gained a median 1.73% in January…compared with .85% for the rest of the year (according to Pavilion Global Markets).
And with that, the January Effect is considered to be a barometer of the market for the rest of the year…but the fact that something is observable doesn’t make it a powerful predictor.
Since the late 1800’s, when January has been positive, the market has been up for the year 67% of the time. And in comparison, when January has been negative, the market has still been up for the year 55% of the time (MarketWatch). That is just a 12% increase in the odds that a positive January can signal an ‘up’ year for the market.
So basically, there are four possible outcomes: both January and the rest of the year can be positive, or both January and the rest of the year can be negative. Or January can be positive while the rest of the year is down, or vice versa. In other words, January doesn’t really tell us anything.
The bottom line: should investors play the January Effect?
In short, no. You might as well flip a coin. As a forward indicator of market direction, the January Effect has basically no value. It is a statistical observation, not an investment strategy.