January Seasonality and Its Impact on Your Portfolio

As market participants, we want to weigh evidence which will help us make money in the markets. After all, that’s why we’re in the market, right? We’re not in the market to have strong opinions or have bragging rights to say, “I’m right.” From experience, I can tell you that pride and market participation do not go together. We’re simply in the market to make money. We shouldn’t care about being “right.” We should only care about being on the right side of the trade. As we work hard to be on the correct side of the trade, one piece of evidence to consider is something called seasonality. Seasonality, in relation to markets, is simply the recurrence of similar price movements during certain periods of the year. It’s the tendency for stocks (or bonds or commodities) to perform better during some time periods and worse during others. For example, Yale Hirsh of the Stock Trader’s Almanac discovered the six-month seasonal pattern or cycle. Since 1950, the best six-month period for the S&P 500 runs from November to April. By extension, the worst six-month period runs from May to October. There are many more examples, but for today, let’s focus on January. Is there anything about January that can give us an advantage? Funny you should ask. You didn’t ask, but you read that question in your mind as if you asked. So let’s answer the question you didn’t, but wanted to ask. The answer to this question is a resounding YES. January can give us some key insights into the possibilities of performance in the year ahead. Nothing is guaranteed, but let’s dig in and understand the different ways January can give us an edge.

 

First Five Days in January

For 2017, the first five days of January ends today. And over the past 41 times where the first five days of the year were up, the subsequent full-year gains have been up 35 times. That’s a hit rate of 85%. The average gain during such years was roughly 14%. Not too shabby. On the flip side, the first five days in January are a less reliable indicator when negative. When this takes place, the positive or negative return for the remainder of the year is almost a coin flip (about 48% accuracy) with an average gain of just 0.2%.

 

Down Januarys Warn of Trouble Ahead

Looking at the S&P 500’s performance in January going back to 1950, every down January with one exception (2016!) preceded a flat market, a 10% correction, or an extended bear market. Except for 2016 (which had one of the worst starts in market history), when the first month of the year has been down, the rest of the year followed with an average loss of almost 14%. (PS, when an indicator with such a strong track record results in an opposite outcome, market participants should pay attention to the significance. The fact that 2016 did not finish down is something to note.)

 

The January Barometer

“As Goes January, So Goes The Year.”

When the S&P 500 records a gain in the month of January, history suggests that the rest of the year will benefit and finish up as well. Since 1950, this indicator has an amazing hit rate of almost 90%. Specifically, 88.7% of the time, when January records a positive return in the S&P 500, the year finishes positive as well. Pretty incredible.

 

January Barometer Portfolio

This is a tendency for the Standard & Poor’s top performing industries in January to outperform the S&P500 over the next 12 months. As described by Sam Stovall of S&P Capital IQ, it’s an effective way to align your portfolio for the remainder of the year. If on February 1st, you invested equally in the 3 best performing sectors in January and held them until February 1st of the following year, you would’ve received a compound rate of growth around 8% as compared with 6.6% for the S&P 500. In addition, the opposite applies. If you bought the worst performers in January, you would’ve underperformed the market with about a 5% return. Since 1970, the compounded growth rate of the ten best performing sub-industries (based on their January performance) was roughly 14% compared to about 7% for the S&P 500. In addition, these ten best performing groups in January went on to beat the market in the subsequent months nearly 7 out of every 10 years, while the worst performing sub-industries outperformed the S&P only 38% of the time. Conclusion: we’re better off letting the January winners ride rather than trying to bottom pick from the January losers.

 

The January Effect

Different from the January Barometer, but just as significant, The January Effect is the tendency for Small Cap stocks to outperform Large Cap stocks in January. Many speculate as to why this happens. But we don’t need to get caught up in the why in order to benefit. And frankly, many us of already know that we could call this the mid-December Effect. From 1953 to 1995, small caps outperformed large caps in January 40 out of 43 years. However, about 30 years ago after the crash of 1987, this tendency shifted to mid-December. Even more recently, during the past five years, it appears this has shifted earlier to November. We’ll need a few more years of tendency before we can rename this The November Effect.

 

In about a month, we’ll revisit these indicators to see how they performed and what type of insight they might provide. Nothing is guaranteed, but with some impressive accuracy in play, it makes sense to add January seasonality to our process when identifying opportunities and working to get ourselves on the right side of the trade.

Here’s to enjoying another year in the markets!

As always, you can see our daily market thoughts on this and other opportunities on Twitter @360Research

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Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security. You invest based on your own decisions.