As January goes so goes the year..?

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The much anticipated January bull continuation has not yet played out this year as the S&P 500 is down around 3% with just a few trading days left to go…

If we take only the first five days of January, this also reveals non too encouraging historical stats as the market declined here too, although only slightly. It seems that after a tub thumping 29% increase in the S&P 500 last year, investors are finally repositioning their portfolios and taking profits off the table while they can.

Some people such as Nobel Prize Winner Eugene Fama would probably tell you that there is no January effect (then again whatever most Nobel Prize winners in economics should be disregarded!!). If markets are efficient, arbitrage would erase any slight opportunity to earn abnormal profits such as those deriving from such a calendar event. If the first five days of January are so great, then why wouldn’t everybody buy at the end of December to sell on the fifth trading day of January? With everyone trying the same, share prices would rise in December and decline at the fifth day of January until the point the profit opportunity is eliminated. Fama’s efficient hypotheses would thus be validated. Of course, we all know that markets are far, far, far from efficient!!

Calendar opportunities very likely depend on many other events. The so called January effect has in fact been much less pronounced in recent years than in the past. With the advent of computers, electronic trading, complex trading algorithms etc etc there’s always some computer program playing for arbitrage opportunities to such an extent that all are eliminated in fractions of seconds. January is also no longer a spectacular month for small caps – the  area where this effect is deemed to be most pronounced.

Still, all this doesn’t mean that there are no calendar effects. There are.  In January, investors tend to relocate their capital, look at their past performance and re-evaluate profit opportunities. They rebalance portfolios, and this definitely does have an impact in the market. The psychology of the New Year period and a fresh start also explains, to us anyway, why the laggards of the previous year generally have a storming start. This is precisely what we have seen this year of course with gold and gold miners – 2013’s laggards – rallying hard whilst global equities have slumped.

If investor’s actions vary from month to month, then there must be some kind of impact, even if not exactly a profit opportunity. Instead of a profit opportunity, January may represent a barometer, telling us what to expect from the year. We can thus obtain potential direction from January behaviour that increase the odds of a certain scenario playing out…

What this year’s January performance tells me is that investors are now playing a “waiting” game, as they no longer believe in the rally. Even if economic data has been improving during the course of last year, investors believe that the unfolding of the quantitative easing program in the States will have a large negative effect as liquidity is gradually drained from the markets. Absent a sharp rally later today on the conclusion on the FOMC meeting that puts the S&P in the black (and that would be a very sharp rally indeed of near 3%!), the sluggish January tells me that I should be wary…

Filipe R Costa

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