January Effect

The “January Effect” is a popular phrase has caught headlines lately in the investment world, which theorizes that there is a seasonal increase in stock prices to start a new calendar year.  After the last three Januarys it’s easy to see why this theory may have legs.  In 2017, the S&P500 was up 1.79% in the first month, followed by 5.62% in January of 2018, and a whopping 7.87% this year. Why has January offered such impressive returns lately and what does that mean for the rest of the year?

The logic behind the “January Effect” is somewhat suspect, but there are a few potential factors that could lead to a strong start to a calendar year.  First, investors typically do their tax-loss selling at the end of the year, not at the start of it. This generally means there is more buying pressure than selling pressure in the early months.  There is some truth to this, as we commonly advise clients to sell losing positions to take advantage of tax losses as the year progresses, but rarely do so for tax-purposes in January.

Secondarily, January is also a popular time to re-evaluate financial plans, and make retirement plan contributions, which generally flow into stocks.  As the year progresses, higher income earners typically max out their retirement plan contributions and the pace of contributions slow, but January offers a clean slate for contributions. As 401k and IRA contributions flow into retirement plans, they increase the demand for stocks and drive prices higher.

Finally, a case can be made that optimism tends to increase around the start of a new year.  Resolutions are made, diets are begun and attendance at the gym increases.  It’s a time of new beginnings and hope.  Perhaps that optimism spills into financial markets.  All of those factors have led to the term “January Effect.”

Historically, January has been a good month, but not the best.  The average return for the S&P500 in January is 1.2%, which ranks 4th behind April, July, and December. 63% of the time January provides a positive return.  December ranks highest at 72%. Unfortunately, we can’t glean much about the rest of the year from a strong January. It’s best to just enjoy the rally.

This year is somewhat unique to previous January rallies because of the weak December performance.  Even after the strong January rally, the market still sits below the starting point in December. In fact, last December’s performance was the worst since 1931, leading to extremely oversold conditions.  So, what’s next?

The pendulum appears to have swung too far in the other direction in the near term.  The strong start to the year will likely find resistance soon.  Corporate profit margins peaked at an all-time high last year and are likely to retreat some this year under wage pressure and higher interest rates.  The benefits of tax reform are all baked in and earnings growth likely slow to mid-single digits.  We may not see a recession in 2019, but we wouldn’t be surprised to see a noticeable slowdown in economic growth.  

September marked a high-point for US stocks.  Since that time, US markets have been in a downward trend.  Despite the strong January, we suspect that trend will continue in the near term. Investors are still paying a premium to own stocks, but the reasons for doing so are shrinking.

Any opinions are those of Brady Raanes and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.