Michael Lipper: what lies behind the 'January Effect'

There are no perfect rules about investing. Everything we think we know should carry with it a notation of a margin of error.

One of the advantages that I had growing up was to learn that one could have a winning day at the thoroughbred race track by cashing tickets only on one third of the races; in other words by picking one’s bets carefully and knowing when not to bet.

The big advantage, in theory, that individual investors have over most fund managers is that individuals can be like me and not bet every race because of a lack of conviction as to its outcome or that the odds did not have an appropriate risk/reward ratio imbedded in the bet.

My long-term analysis of the historical records of investors who stay in the game is that they are right on the order of 50% of the time and if they wind up by having more of their money on winning positions, can come away a monetary winner being right only 40% of the time.

I believe most fund managers that have long-term records of ten or more years are right around 60% of individual quarters and years. The great ones are right perhaps two-thirds of the time.

With all that as a statistical prelude to indicate that being wrong is part of the game, I turn my attention to the remarkable first week of January trading.

US stock prices were up roughly 5% in the four trading day week. One of the favorite market tales is that there is a “January Effect” which states that as January prices go, so goes the year.

The believers in this theory are encouraged by the first day’s trading and the first week’s as well.

Historically the “January Effect” does work, as do most months in most years. (The US market goes up over time most of the time.)

The January Effect

There is some reasoning behind the belief in the “January Effect.” In early January many pension funds, 401(k) and similar plans get their money destined for the equity market and therefore they are buyers.

Despite all the dour headlines and pundits’ chatter, the first week is actually a continuation of the halting rise in market prices that was evident in the fourth quarter of 2012.

Nevertheless, the purpose of this post is not to jump on the momentum train, knowing full well about error rates and that optimism is contagious and often leads to unfulfilled results.