As investors ring in the new year, some may see the occasional headline about the “January Effect”.
This theory suggests that the price movement of the stock markets during the month of January may signal whether it will rise or fall during the remainder of the year. In other words, if the return in January is negative, this would supposedly foreshadow a fall for the stock market for the remainder of the year, and vice versa if returns in January are positive.
To examine this idea, we have looked at the world’s largest stock market where there is more than 90 years of reliable data, the US. Have past January returns of the top 500 companies in the US, the S&P 500, been a reliable indicator for what the rest of the year has in store? If returns in January are negative, should investors sell stocks? Exhibit 1 shows the monthly returns of the S&P 500 Index for each January since 1926, compared to the subsequent 11-month return (i.e., the return from February through December). A negative return in January was followed by a positive 11-month return about 60% of the time, with an average return during those 11 months of around 7%…
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