There are two indicators that are worth noting in looking at the markets for 2023: The January Effect and The January Barometer. Both are flashing green lights for stocks. Allow me to explain.
The January Effect is a perceived seasonal increase in stock prices during the month of January. Analysts generally attribute this rally to an increase in buying, which follows the drop in price that typically happens in December when investors, engaging in tax-loss harvesting to offset realized capital gains, prompt a sell-off.
Another possible explanation is that investors use year-end cash bonuses to purchase investments the following month. While this market anomaly has been identified in the past, the January Effect seems to have largely disappeared as its presence became widely known.
KEY TAKEAWAYS
- The January Effect is the perceived seasonal tendency for stocks to rise in that month.
- In the bigger picture, since 1938, 29 out of 30 years of gains seen in January-February resulted in average yearly S&P 500 advances of 20%.
- The January Effect is theorized to occur when investors sell losers in December for the tax-loss harvesting, only to re-buy new positions in January.
- Like other market anomalies and calendar effects, the January Effect is considered by some to be evidence against the efficient markets hypothesis.
Understanding the January Effect
The January Effect is a hypothesis, and like all calendar-related effects, it suggests that the markets as a whole are inefficient, as efficient markets would naturally make this effect non-existent. The January Effect seems to affect small caps more than mid-caps or large caps because they are less liquid. We moved 50% of our money to small caps last fall for two reasons: one because of the January effect and secondly because during an economic downturn, small caps typically outperform large caps.
Since the beginning of the 20th century, the data suggests that these asset classes have outperformed the overall market in January, especially toward the middle of the month. Investment banker Sidney Wachtel first noticed this effect in 1942.
Beyond tax-loss harvesting and repurchases, as well as investors putting cash bonuses into the market, another explanation for the January Effect has to do with investor psychology. Some investors believe that January is the best month to begin an investment program or perhaps are following through on a New Year's resolution to begin investing for the future.
Some researchers are not convinced that the January Effect is relevant while other researchers have found that January Effect still exists, but only for smaller-cap stocks, owing to a lack of liquidity and interest from investors.
What is the January Barometer?
The January Barometer is summed up in a single easy-to-remember phrase: "As January goes, so goes the rest of the year." This tidy maxim seems to have reasonable evidence to back up its record for prognostication, but trading it might require judgment and skill.
This indicator was first printed in the publication "The Stock Trader's Almanac" and authored by Yale Hirsch, who first mentioned it in his 1972 edition of the book. Since 1928, the S&P 500 has had 91 occasions to test the January Barometer, and in 63 of those years, the market did close in the direction that January took over the remaining 11 months of the year. By comparison, all other months, on average, were significantly less likely to be as well correlated as January. Last year, despite the strong market prior to January, the market in January 2022 was down. 2022 reflected the downturn in January
The January Barometer is right more often than not, but it leaves a lot to be desired as a trading or investing rule. Instead, consider it an indicator of overall market health. That way, you can maintain a bullish stance and use it to improve confidence in your trading during a year when January has closed higher for the month.
The bottom line is the January Effect and January Barometer have a high probability of being correct for the rest of the year and for the month of January. Not a sure thing, but an indicator of the health of the market and economy.
This year, January markets, S&P 500, DOW, and Nasdaq, are up nicely for January and, in my opinion, indicate a strong market for the year. Understand that this means the market will end the year up over 20%. It does not mean that there will not be volatility along the way nor that the markets will not recede from current numbers. The markets will be up strongly in the second half of the year based on the Fed pausing their interest rate tightening sometime in the next three months.
We have moved to value/high dividend stocks and small caps so that we have downside protection and are positioned for the upturn. Unless I see some surprises in Fed policy or in economic numbers, I am confident this is going to be a very good year.
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