Which Way After A Negative January?

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With the S&P 500 index having recorded a -3.6% return this January, newspapers and other financial publications have trotted out their “January Effect” stories. Such stories, with minor variations, follow the theme that “As goes January, so goes the year.” Not surprisingly, that’s not always true.

Using data from the Ned Davis Research Group, since 1950 the S&P 500 index has declined 25 times in January. Excluding 2014, the index has been down in 13 of those calendar years that began with a negative January. If we exclude the effect of January itself, the index has declined from February through year-end in 11 of the 24 years. As a predictor of market direction, the January Effect is not much better than a coin flip. Since markets rise in most years, however, it might provide benefit by simply raising investors’ level of caution. When January has been positive, the index has averaged a 12% return over the subsequent 11 months. When January has seen the index decline, the S&P 500 has been effectively flat for the rest of the year.

Of course, averages can’t tell us what will happen in 2014. While the following 11 months after a negative January have substantially underperformed those with a positive first month, there have been a few significant exceptions: +29.9% in 2003 and +35.0% in 2009. Those were both years in which the Federal Reserve Board was actively stimulating the economy and markets to pull the country out of recession and away from major stock market troughs.

In 2014 the Fed announced its intention to continue its aggressive stimulus, while gradually reducing the amount of its new money creation as the year progresses. We are left to discern whether the effects of stimulus will have the same positive effects as in 2003 or 2009, or whether the air comes out of the balloon with investors losing confidence in central bankers’ ability to control economic and market outcomes. It promises to be an exciting year.