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Sell in May, Buy in January?

Overall market gains for the year seem to be stronger when January is positive

IG 3 January, 2013 | 12:48AM

This is part of Morningstar's 'Perspectives' series, which features contributions from third parties such as asset managers, academics and investment professionals.

Among the many stock market clichés, the ‘January effect’ is one of the most well-known. The premise is that the stock market usually rises in January, as investors that had sold out of their holdings in December, to book profits and offset losses, buy back into the market, creating a wave of buying pressure. 

This effect held true in 2012, as the chart below shows, with the FTSE 100, S&P 500 and Dow Jones Industrial Average all starting out well in the first month and then going on to end the year higher:

We took a look at data for the three indices to see if this old statement still held
true. The data does show that markets have risen in January in a majority of the
years from 1984 to 2012, and further overall gains for the year are stronger when
January was positive.

New Year Optimism

To test the hypothesis, we collected data spanning the period 1984 to 2012. 1984 was the year that saw the introduction of the FTSE 100 in the UK, replacing the FTSE 30 as the premier index on the London stock market. This gave us 29 years of data to examine.

Out of those 29 years, 17 saw a positive start to the year. 17 positive Januaries out of a potential 29 equates to a 58.6% chance that the first month of each year will see a gain for the FTSE 100.

In the US, the potential for a positive first month is even greater. During the same period, the S&P 500 and the Dow Jones rose 19 out of 29 times, or 65.5% of the time. The overall average gain for the whole 29 years is 1.13% for the S&P 500 and 1.07% for the Dow Jones per year.

The Rest of the Year

There is, of course, no ‘sure thing’ in financial markets, and the above data shouldn’t be taken to mean that the stock market will always rise during the month of January.

However, there is another, more interesting, possibility that arises from our look at returns during the month of January. The following table shows the average return for the FTSE 100, S&P 500 and Dow Jones in the period 1984 – 2012:

Index Average Annual Return, 1984 - 2012
FTSE 100      7.43%
S&P 500 8.85%
Dow Jones    9.34%

However, in those years that enjoyed a positive January, the average return for the year overall was much better:

Index Average Annual Return, 1984 - 2012
FTSE 100      11.94%
S&P 500 13.88%
Dow Jones 13.99%

The graph below is an average of the movements of the three indices, showing
that years with positive Januaries usually enjoy better gains:

As with any rule of thumb, there are exceptions. There were some years during our sample that saw a positive January but still resulted in the market finishing the year lower. For the FTSE 100, these years were 1994 and 2001, while for the S&P 500 and Dow Jones 2001 was also a bad year. This was likely due to the impact of the September 2001 terrorist attacks, which resulted in the temporary closure of US markets and a loss of confidence among investors.

It is also the case that a poor January can mean a more difficult year, as occurred in 1990, 2000 and 2008, but we would suggest caution about drawing too much of a conclusion from this observation. January 2009 and 2010 are classic examples; both saw losses for the first month but then the rest of the year saw excellent gains, with the three indices gaining an average of 21.45% and 10.93% respectively.

What About 2013?

No one, of course, has a crystal ball. But it must be said that, while the outlook for global markets doesn’t look great, there is still the possibility that 2013 will start well. There is still plenty to be concerned about, including the US fiscal cliff, slowing Chinese growth and the eurozone crisis. However, the end of 2011 looked equally unpromising, and yet January 2012 saw the three indices gain an average of 3.24%.

This article was written by Chris Beauchamp, a market analyst at IG.

Morningstar Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com.

IG Disclaimer
No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. The research does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

 

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About Author IG

IG  specialises in Contracts for Difference (CFDs), spread betting and FX. It is headquartered in London and part of IG Group.