The January Effect & The Year Ahead

The so-called January effect for the stock market (S&P 500) looks quite weak when measured on a monthly basis, and it doesn’t offer much more encouragement as a signal for the 1-year-ahead return horizon either.

To understand why, let’s compute average returns for each month for the past 20 years. Next, let’s plot those monthly average returns against the average of subsequent 1-year returns, measured from the end of the month in question. The result is the chart below. As you can see, the average January return is virtually nil over the past two decades. Yes, subsequent 1-year returns measured from January’s close are near the highest compared with the other months. But the comparable 1-year average performance from the end of February is equally high and March’s results are slightly better. In addition, the average 12-month return after April’s close is nearly as strong as January’s. The question is whether there’s a strong relationship between January’s returns and the year ahead? If there is, it’s not obvious in recent history.

The relationship between monthly return and subsequent 1-year performance looks more or less random in the chart above. That’s certainly the message in the R-squared of roughly zero for these plots. It’s hard to see the logic in basing investment decisions on the January effect. The first month of the year appears to be related to above-average returns in the year ahead, but the same can be said of three other months in the early part of the calendar. But all’s not lost. Maybe we can re-title the January effect as the January-through-April effect.