The January Effect: Is It Effective?

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"The January Effect" on the stock market, first observed by Don Keim a graduate of The University of Chicago, is the theory that the market receives a boost in the first five days of the year caused by investors selling losing positions at the end of the year to claim capital losses for tax reasons and then re-invest at the beginning of the year at discount prices. Another part of the theory is that the performance of the market in January especially the first five days is used as a predictor and will set the trend for the performance of the market the remaining eleven months of the year.

• 85% of the time the S&P 500 has seen a rise the first five days of the year, the index has followed suit the remainder of the year.
• 32 of the last 39 years the performance of the S&P 500 has followed the direction of the index in January for the following 11 months.

The bad news is that we just suffered the worst January ever for the S&P 500 down 8.6% for the month weighed down heavily by the struggling banking and financial companies. All is not lost however as this theory is not as accurate at predicting the future in down January's, only about 50/50. And as bad as the S&P 500 has performed this month the index was up after the first five days. Another positive is that the five worst January's ever for the S&P 500 have ended with a rise in the index for the rest of the year.

S&P 500's Worst 5 January's

1. 1970 - down 7.6% but squeaked out a slight gain +0.1 for the year.
2. 1960 - down 7.1% but recovered half of those losses by the year's end.
3. 1990 - down 6.9% but rose 3.9% for the rest of the year.
4. 1939 - down 6.4% but rose 1.3% for the remainder of the year.
5. 1978 - down 6.2% but rose 7.7% for the final 11 months.

    

Let's hope 2009 is able to rebound as the other year's with the worst January's did.