If you’ve been around the stock market long enough, you’ve probably heard of the “January Effect,” sometimes called the “January Barometer” or “January Indicator.” The idea is that whatever the S&P 500 does in January foreshadows its performance for the rest of the year. If the index shows a positive return in January, the rest of the year should follow suit, and if it is negative, it may be time to sell stocks–at least, that’s what those say who believe in this particular market proverb. It’s sort of like the old saying that if March “comes in like a lamb” weather-wise, it will “go out like a lion.”
But does this bit of market prognostication hold up to the facts? Well, let’s examine the facts. Since 1926, a negative return of the S&P 500 Index in January was followed by positive returns for the next 11 months about 60 percent of the time (see the chart below). The average positive return for those 11-month periods following a negative January was around 7 percent.
More recently, in 2016, the S&P 500 had its worst beginning performance on record; it declined 7.93 percent during the first two weeks of the year. The index ended January down 4.96 percent, its ninth-worst January performance ever. But for the rest of the year, the S&P 500 returned about 18 percent. Factoring in the awful January numbers, the index was up about 13 percent for the year 2016.
In other words, if you had followed the advice of the January Effect and sold your equities in January 2016, you would have missed out on a major increase in the value of your holdings by the end of the year. In the majority of the years since 1926, you would have similarly lost out on gains you could have achieved by simply waiting out the January downturn.
The moral of this story is that in most cases, for investors holding a well-diversified portfolio of carefully selected and properly allocated stocks, patience will be rewarded. Conversely, those who divest or otherwise alter their strategies on the strength of “conventional wisdom” or market proverbs like the “January Effect” will experience much lower returns. Rather than chasing hot tips or trying to avoid the temporary drops that are a normal part of the market cycle, investors are usually better advised to allow the equity markets to do what they have done so well for nearly a century: reward disciplined investors with meaningful growth over time.