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Beware the January effect and other investing myths

Jason Prowd  |  08 Jan 2019Text size  Decrease  Increase  |  
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  • The January effect is one of a few theories about seasonal market movements.
  • Many of these ideas are decades old and there’s scant evidence that they hold true.
  • Research shows that timing the market based on just about any theory just doesn’t pay.

The January Effect is a dream scenario for investors eager to get ahead on building wealth with a buy-low/sell-high investing strategy. Seasonal trends force prices down, you get your asset for a bargain price and then sell when the promised rebound happens within just days, weeks or months.

But do such patterns of predictable peaks and troughs in the markets really exist? Or are they the unicorns of the investing world – a fantasy symbol of good fortune everybody knows doesn’t really exist. And just how likely is it for any investor – regardless of their experience or the amount of research they’ve done – to benefit from this sort of phenomenon?

What’s the January effect all about? 

The January Effect, a term coined by American investment banker Sidney B. Wachtel in 1942, is said to be a seasonal gift to US stock pickers. Thanks to an expected dip in values in December, followed by a surge in the following month, the theory goes that well-timed buying and selling can earn you a hefty return.

Investing pundits put the December dip down to a couple of likely factors. One is that investors seeking to offset potential capital gains at the end of the US tax year – which, unlike Australia, coincides with the calendar year – fuel market falls by selling loss-making shares. The other factor is known as “window dressing” – investment managers dumping poor performers from portfolios to whitewash end-of-year reports to clients.

More money to go around is the thinking behind a January lift in prices, with cash bonuses potentially putting more in investors’ pockets. That, and the general sense of optimism we associate with a fresh start to the year, might account for Wachtel’s original observation that stock prices rise more in January than any other month.

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What about other ‘calendar’ effects?

What you may notice is that it’s been more than 75 years since this January blip first registered. In that time there have been a lot more theories about other calendar events – weekends, seasons and public holidays – that could tempt investors with a cast-iron buy-low/sell-high opportunity. On long weekends, for example, anxious investors are perhaps more likely to let volatile assets go before the break, just in case, driving prices down for a spell.

But before you start saving calendar alerts to shop for shares leading up to Christmas, Australia Day or Good Friday, it’s worth remembering that even if these theories were once true, they’ve probably been cancelled out or even reversed by now. Markets are generally efficient: if enough investors jump on these opportunities then any benefit that could have existed should have been cancelled out.

Simply put, markets are way too complex to allow simple ideas such as “buy stocks in January” to be true.

Fortune favours the patient investor

At Morningstar, our researchers study what works for investors and what doesn’t. That’s why we’re confident in saying that timing the market generally makes for lower returns than playing a longer game, no matter what you’re investing in. And even if investing strategies based on calendar effects or other identified “patterns” pay off, you’ll need more than a modest gain to make it worthwhile. Trading or management costs, together with your tax liability, could see you part company with a hefty chunk of a lucky windfall.

Thanks to the phenomenon of compound interest – which is not a myth – investing sooner rather than later is likely to see you doing better financially. That’s assuming you can hold on to your assets while the market evens out over time. While past performance is no indicator of future performance – as investment companies like ours are fond of saying – history has shown time and again that markets recover and, as a result, fortune favours the patient investor.

is a senior product manager for Morningstar Australia.

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