John Manley

The January Effect: A nice finish to a good start

AdvantageVoice® Blog—2-4-13
John Manley, CFA, Chief Equity Strategist

“What we call the beginning is often the end.” T. S. Eliot

Back in my youth, the technicians with whom I worked developed a theory on the inferences that could be drawn for the equity market from a strong start to a new year. They called it “The January Effect.”

The thesis was quite simple and straightforward: If the equity market rose in the first few days of the new year and then continued its rise over the course of the remainder of the first month, then equity prices might post a stronger than normal showing in the remaining eleven months of the year. Since it appears that the S&P will fulfill that requirement this year, I thought it might be interesting to go back and examine the historical precedents.

Two things must happen to produce the January Effect (JE): the S&P must close higher on the fifth trading day of January than it did on the last trading day of December AND it must close higher on the last trading day of January than it did on the fifth trading day. That is all it takes.

As the attached table demonstrates, prior to 2013, this has occurred 24 times in the last 64 years. During that period, the average price appreciation of the S&P from the end of January through the end of December was 7.4%. The average gain in years with a January effect was 13.4% and the average gain in non-January effect years was 3.8%. It was not a perfect predictor, but the market rose over the course of the last 11 months in 87.5% of the JE years and in only 70% of the non-JE years.

Even the failures were not that bad. Two of the three declines were less than 5% (which would have been largely offset by dividend income in those years). The big loser, 1987, saw an almost 10% drop, but this occurred only after a more than 20% post January advance. It is interesting to note that, with the sole exception of 1994, the S&P was up more than 5% from its January close at some point before the year ended.

What do these numbers mean? It is technical analysis and, as such, there is the risk that it is nothing more than moonbeams and sunspots. I think there is more to it than that. Momentum means something on Wall Street and momentum seems to be pushing the uninvested towards the equity market. According to Lipper, we just had three consecutive weeks of positive flows into equity funds, the largest since 2001. When people see success, they want to jump on the bandwagon and that can be a powerful force. As we wrote last week, being out of the market when it rises can be almost as painful as being in when it falls.

Regardless of the reason, the numbers do speak for themselves. I do not think what they say is conventional wisdom. Some investors have greeted the strong January stock market with renewed enthusiasm. Others have found simply higher prices and more concerns. Whatever the current outlook for the future; the historical fact is that a strong January usually has begot a strong year. Perhaps we can look for the reasons at the beginning of 2014.

The views expressed are as of 2-4-13 and are those of Chief Equity Strategist John Manley, CFA, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.


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