As Goes January, So Goes The Rest Of The Year by Filipe R. Costa

December 2014 was an unusual month in the markets, with plenty of volatility and erratic movements being seen. On one side, oil prices nose dived, while the Russian economy sank with it. The Central Bank of Russia even had to hike its key interest rate by an astounding 650 basis points in a final desperate attempt to put an end to the Russian currency being decimated relative to the dollar.

Investors panicked, energy stocks were battered, and the Santa rally vanished. But, on the other hand, the Fed acted to neutralise the bearish sentiment and restore the Santa spirit. Even though no one could trade on Janet Yellen’s speech, at least the Fed statement was full of keywords that computer bots loved, which was enough for them to start trading at the earliest possible nanosecond. The speech was enough to turn a non-event into panic buying, restoring the order. The S&P 500 erased its December loss, which at one point was near 4.6%. By New Year’s Eve everything was fine again and investors took a deep breath while opening the best French champagne for the sixth consecutive year..

But now that 2014 is history, it’s time to look forward to 2015.

With six consecutive years of positive performance and many challenges to come, 2015 may be a turning point. While the US has been showing some positive data indicating the end of the recession, the world seems to be under muddy waters. Europe has just seen confirmation of deflation, Shinzo Abe kicked his promised reforms and tax increases into the unforeseeable future, China is cooling, oil prices lost half their value threatening to push several countries into recession, and let’s not forget that there’s no more QE in the US to boost equity prices.

Contributing to the grey picture is also a Greek election that may bring a new wave of trouble to the already rotten European construct. The fundamental picture is shady and points to a new year that may end flat at best. But let’s take look at the price data and check in which direction it points.

For those that like statistics and market psychology, January is a great time to collect important data regarding the rest of the year. As they say: As goes January, so goes the rest of the year.

January is not only traditionally a good month for equities due to portfolio reallocations, but also a gauge for performance during the rest of the year. In an article published in January 2012 (http://www.spreadbetmagazine.com/blog/weekend-reading-as-goes-january-so-goes-the-rest-of-the-year.html) we took a deeper look into this. Two years later, let’s update with fresh data.

Looking at the main data

The data collected covers the period between 1955 and 2014, corresponding to 60 years/periods for the S&P 500 index. During the period, the S&P 500 rose 44 times (73% of the cases), recording an average annual growth of 8.34%. Considering just the month of January, the S&P 500 rose 36 times (60% of the time). Even though the proportion of positive Januaries is less than average, its performance is better. While the average monthly performance has been around 0.67%, the average performance for Januaries alone has been 0.96%. So it seems there is in fact a January effect playing out here.

Is January a bellwether for the year?

Our main interest is not in understanding how good the January performance has been but in understanding whether we can use its performance as a gauge for the future, rest of the year, performance.

The main goal is to correlate the January performance with the rest-of-the-year performance (February to December). There are three potential outcomes:

1. After a strong January there is a reversion in performance during the rest of the year. If that is the case then we should implement contrarian strategies.
2. After a strong January the market continues rising during the rest of the year. If that is the case then momentum strategies dominate.
3. There is no clear cut relation. If this is the case, then we just can’t use the January performance as guidance.

To investigate the issue we rank our 60 observations from highest to lowest and split the data into four different groups. The table below summarises the results obtained.

The data inside G1 contains the best performing January months for the last 60 years. In 14 out of 15 cases, the rest-of-the-year performance (February to December) was positive. Curiously, the best January ever is also the only case in G1 in which the rest of the year performance is negative. But, provided that the year under consideration is 1987, that is understandable. In fact, that year was marked by the “Black Monday” in October, a day in which the S&P 500 lost 20%.

G1 shows an average January performance of 6.98% and an average rest-of-the-year performance of 15.58%, which suggests there is a strong momentum effect playing. From the data it seems that investors tend to buy more after a strong January.

G2 includes the following 15 best January performances. In this group there are still 15 positive Januaries but the average performance is much lower than for G1, at 2.93%. The number of rest-of-the-year positive performances drops from 14 to 12 and the average performance drops to 8.79%.

In G3 we have 6 positive and 9 negative Januaries, with the average performance being -0.72%. The rest-of-the-year performance is still positive but drops again, this time to 1.75%. The number of rest-of-the-year positive performances also drops to 10.

G4 is composed of the worst Januaries ever. In this group the average January performance is -5.37% and the performance is negative in all 15 cases. The number of rest-of-the-year positive months drops to 9 but the average rest-of-the-year performance increases slightly to 2.45%.

Looking at the four groups, we can say that January seems to be a very good barometer for what is going to happen in the rest of the year.

When the performance seen in January is strong, the market seems to continue the trend for the rest of the year. When the performance is mild or negative in January, on average the market seems to still rise but with much more volatility and uncertainty. The difference in volatility between G1/G2 and G3/G4 is substantial. It may be worth waiting a few more days to see how January goes before entering the market.

What about the trading performance in the first five days?

For all those that are anxious to enter the market before all others do, there is another bellwether that is sometimes used to forecast the rest-of-the-year performance. We are exactly at the right point to use it.

Investors say that the first five trading days of the year set the mood for the rest of the year. If that is true, then we can look at the first five sessions of 2015 and predict the rest-of-the-year performance.

After the first three trading sessions the S&P 500 was down by 2.74%, which wouldn’t anticipate a favourable year. But as in December, the FOMC played its role again and the market managed to close the five first trading days with a gain of 0.17%. But the positive number alone doesn’t say much. We need to rank it in order to understand how it compares with the preceding 60 years. We again ranked years by performance but this time using the first-five-days performance and then split the data into four groups as before (groups 5 to 8).

As before there is a significant correlation between the performance recorded in the first five trading days of the year and the rest-of-the-year performance. When the performance for the first five days is high, new investors are attracted into the market and prices tend to continue rising.

G5 aggregates the best performing years in terms of the first five days, with performance ranging from 6.24% (1987) and 1.84% (2012). On average, the performance for the first five days of the year in this subset is 3.14% and the rest-of-the-year performance is 14.85%.

Going to the next subsets, G2, G3 and G4, we find that as the average first five days performance decreases so does the rest of the year performance. G8, for example, shows an average first five days performance of -2.73% and a rest-of-the-year performance of 0.6%, which is still positive but much lower than for any other group. These results are in line with those for the full month analysis. Both January and the first five trading days of a year seem to be strong bellwethers for the rest of the year performance and are worth a look.

What to expect this year?

Let’s now put into perspective the performance seen in the first five trading days of 2015. The S&P 500 rose 0.17%, a number that lies inside G7. This group’s rest-of-the-year performance is 6.68%, which is positive but not at the top of the table. At the same time this group also shows much larger volatility for the rest-of-the-year returns, which means there is a high likelihood of performance being much different from the 6.68% average.

The above finding should not come as a surprise. Markets are going up and down with no defined direction as the future is grey. This year will be marked by several risks, as already mentioned, and investors are becoming a lot more cautious, in particular after a six-year run that saw the S&P 500 triple its value. The performance for the first five trading days is in the mid to low table range, which very well depicts the anticipated uncertainty. Let’s wait for the final January numbers to confirm the effect but I would say that this year we won’t have a strong playable momentum effect.