How To Assess The Stock Market January Effect And January Barometer For 2023

Historically, January has seen some unique stock market trends. The first is that smaller and statistically cheaper stocks tend to perform better during early January. Secondly, January itself is often a relatively good month for stocks at least based on 1941-2003 data, though that has been called into question more recently. Lastly, early January has had some predictive power for overall market returns for the year. None of these trends are a sure thing, but they have historically had some predictive power.

The January Effect

Mark Haug and Mark Hirchey of the University of Kansas in a 2005 paper examined data from 1802 to 2004. They found that small cap stocks tended to outperform in January on average, and that momentum stocks (stocks that have risen strongly in price recently) tend to underperform in January.

This is potentially due to tax-loss harvesting as investors sell losing stocks at the end of the year, and then buy them back in January to help optimize tax-adjusted performance. As market trends go, this one has a relatively robust history and researchers often find the effect to be statistically significant. That’s no guarantee that it will work in future, but it is surprising to see this sort of trend in markets that are considered to be generally efficient.

January As A Good Month For Stocks

Historically, looking over the 1941-2003 period January has offered the best risk-adjusted and absolute returns, on average, when compared to other months of the year.

However, over the past decade, the outperformance of January appears to have faded somewhat. It’s unclear if this means that the something has fundamentally changed, or, since these effects only offer a slight edge even if when they work, if January has just had a weaker run in recent years that might change in future.

The January Barometer

When January is a down month, it does not bode well for stocks for the remainder of the calendar year. This is called the ‘January barometer’. A negative return for markets in January has historically signaled relatively weak returns for markets for the subsequent 11 month of the year. However, a down January is uncommon, so the statistical power of this forecasting method could be called into question. Still, it is worth remembering that in 2022, January did have a negative return and, of course, that was generally a negative year for the markets.

Caveats

It is worth remembering that financial markets are generally efficient, even when these effects do provide insight, it is often only a slight edge in markets and are definitely not a sure thing. However, historically when applied consistently, this effects have improved returns.

What To Watch For

The implication is that January is often a good month for investors, especially for those invested in smaller and cheaper stocks. Furthermore, if January shows a negative return, that may not bode well for the remainder of the year, as we saw in 2022. However, a negative January does not imply a loss-making year for stocks, just that returns are weaker than average.