Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 142

Do 'January' results foretell the full year for equities?

In Part 2 of our ‘January effect’ examination, we respond to several readers who asked whether the poor January 2016 in the share market foretells a bad result for the whole year, or is the market more likely to rebound because it has been over-sold?

Put another way, based on what happens in January, is there either:

  • a ‘momentum’ effect, where January returns tend to be continued for the rest of the year, or
  • a ‘reversion’ effect, where January returns tend to be the opposite for the rest of year?

History favours a small momentum effect

Historically, positive returns in January have turned into positive full year returns most of the time (80% of years in the US and 72% in Australia). Conversely, low returns in January have turned into low full year returns most of the time. Since 1900, the statistical correlation between January returns and full year returns have been 0.40 in the US market and 0.46 in the Australian market. These moderate positive correlations may indicate the presence of a momentum effect in both markets.

But there is a little sleight of hand going on here. Since the January returns are included in the full year returns, the correlations are artificially high because they double-count January. High return years end up being high partly because of the good start in January (in Part 1, we observed that, on average, January has been the best month in both the US and Australian markets for more than a century).

The problem is that after January’s result is known at the end of January, unless you are Marty McFly or Doctor Who, you can’t go back in time to sell or under-weight shares at the start of the year if January was bad, or over-weight if January was good, in order to get the full year return. All that is important now is the future - the likely return for the rest of the year from the start of February to the end of December.

Since 1900, the correlation between January returns and the ‘rest of year’ returns have been 0.19 in the US market and 0.23 in Australia. These are much lower than the full year results but they indicate a possible weak momentum effect.

If such a momentum effect did persist, we could make excess returns by over-weighting shares for the rest of the year after a good January and under-weighting after a bad January. This sounds like another market anomaly or inefficiency (another ‘free lunch’!).

As statistical correlation numbers are often misleading, ambiguous and say nothing about underlying causes let’s look at the actual results.

Rest of year returns after January – US market

The first pair of charts show that the ‘rest of year’ returns in the US have been higher in years when January was up, compared to years when January was down.

The 10% median rest of year return in years when January was up is significantly higher than the 0.3% median rest of year return in years when January was down.

Also the right chart above shows that in years when January was up, the rest of the year was up 75% of the time, but in years when January was down, the rest of the year was up just 51% of the time. This means the incidence of losses over the rest of the year were more frequent in years that started off with a down January.

The problem with exploiting the January effect

Unfortunately, just like the original ‘January effect’ we analysed in Part 1, what appears to be another ‘free lunch’ also disappears on closer inspection. The above charts look at the period from 1900 to 2015 as a whole, but the next chart takes the 10% median ‘rest of year’ return difference between ‘up January’ years and ‘down January’ years and breaks it into decades.

Positive blue bars indicate decades when the rest of year returns following positive Januaries exceeded rest of year returns following negative Januaries (momentum effect). Red negative bars indicate the opposite - a reversion effect - when the rest of year returns in negative January years were higher than rest of year returns in positive January years.

The decade by decade results show that this effect has largely disappeared in the past couple of decades. The bar on the far right shows the difference since 1990 to be much smaller than the 10% difference over the whole period.

Rest of year returns after January – Australian market

The first pair of charts for Australia show that the rest of year returns have been a little higher in years when January was up, compared to years when January was down, but the difference has not been statistically significant (unlike in the US were the difference has been much larger).

Also the right chart shows that in years when January was up, the rest of the year was up 72% of the time, but in years when January was down, the rest of the year was up 69% of the time. Here too there has been no significant difference in Australia, unlike the US market where the difference has been large.

Reasons for difference between US and Australia

Rather than just look at the numbers, I always try to understand the fundamental drivers at work.

January is a big month in the US: 4th quarter and full calendar year-end profit results, payment of the 4th quarter dividend, and often the announcement of annual dividend increases after the full year results. Much price-changing news for investors to digest and act upon. In contrast, January is quiet in Australia – the long summer break (whereas the US has its long summer break mid-year), no profit reports (most Australian companies have June year-end), December half-year reports are released in February here, not January) and few dividend payments, and rarely if ever any dividend announcements. It is no wonder the results for January compared to the rest of the year have been quite different in Australia and the US markets.

The next chart shows the difference in Australia in rest of year returns between ‘up January’ years and ‘down January’ years broken down into decades.

This shows that the effect has been much patchier and inconsistent than in the US, and is mainly the result of two isolated decades – the 1950s and 1980s. I would not base a strategy on such an effect in the past 100+ years.

The bar on the far right shows the difference since 1990 to be insignificant in recent decades, as in the US market.

Conclusion

In the US stock market there was a relatively strong momentum effect for ‘rest of year’ returns following January’s return. It persisted for many decades in the US but appears to have largely disappeared in recent decades. The reasons for its disappearance are probably the same as for the disappearance of the original ‘January effect’ – widespread access to low cost computing, brokerage rates, futures markets and ETFs, that enabled investors to capitalise on the advantage until it was ‘arbitraged away’.

The Australian market had no such ‘rest of year’ momentum effect. If it existed at all in Australia it has disappeared since the 1990s, as in the US.

It is a reminder to always try to get behind the numbers and understand the fundamental causes and effects before committing investors’ funds to what seems to be a seemingly high correlation suggesting an opportunity for outperformance.

 

Ashley Owen (BA, LLB, LLM, Grad. Dip. App. Fin, CFA) has been an active investor since the mid-1980s, a senior executive of major global banking & finance groups, and currently advises UHNW investors and advisory groups in Australia and Asia. This article is general information and does not consider the personal circumstances of any individual.

 


 

Leave a Comment:

RELATED ARTICLES

Finding the next 100-Bagger

The best strategy to build income for life

Breaking down 2023 returns for the ASX

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Welcome to Firstlinks Edition 552 with weekend update

Being rich is having a high-paying job and accumulating fancy houses and cars, while being wealthy is owning assets that provide passive income, as well as freedom and flexibility. Knowing the difference can reframe your life.

  • 21 March 2024

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Latest Updates

Retirement

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Shares

On the virtue of owning wonderful businesses like CBA

The US market has pummelled Australia's over the past 16 years and for good reason: it has some incredible businesses. Australia does too, but if you want to enjoy US-type returns, you need to know where to look.

Investment strategies

Why bank hybrids are being priced at a premium

As long as the banks have no desire to pay up for term deposit funding - which looks likely for a while yet - investors will continue to pay a premium for the higher yielding, but riskier hybrid instrument.

Investment strategies

The Magnificent Seven's dominance poses ever-growing risks

The rise of the Magnificent Seven and their large weighting in US indices has led to debate about concentration risk in markets. Whatever your view, the crowding into these stocks poses several challenges for global investors.

Strategy

Wealth is more than a number

Money can bolster our joy in real ways. However, if we relentlessly chase wealth at the expense of other facets of well-being, history and science both teach us that it will lead to a hollowing out of life.

The copper bull market may have years to run

The copper market is barrelling towards a significant deficit and price surge over the next few decades that investors should not discount when looking at the potential for artificial intelligence and renewable energy.

Property

Global REITs are on sale

Global REITs have been out of favour for some time. While office remains a concern, the rest of the sector is in good shape and offers compelling value, with many REITs trading below underlying asset replacement costs.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.