Does the January effect really exist? Is the performance of the sharemarket in January an indicator of what's to come over the next 11 months?
Folklore since the 1970s has said that performance of the market in January is a predictor of market returns for the year.
A study by Copper, McConnell and Octchinnkov (2006) studied the January effect for the US market and found that statistically, returns in January were an accurate predictor for market returns for the year. They examined data from 1940 to 2003 and found the effect happened despite investor sentiment and persisted among both large and small caps as well as growth and value stocks.
Another study by Bohl and Salm (2007) looked at the January effect across 14 different countries and found only 3 out of the 14 countries displayed the January effect. Hence, they suggested that the January effect is simply a statistical effect of data snooping.
While most of the studies are concentrated in the US, I decided to apply the study to the Australian market by measuring the All Ordinaries index.
Well, you can see from the table that the January effect seemed to happen in 13 out of 20 years! But you can also see there isn't a strong link when applied to the Australian sharemarket. In fact, you would have the same result if you applied the assumption that the Australian sharemarket tended to move up. In that case, you would have been right in 15 out of 20 years.
Unfortunately, statistics seem to be just that — statistics! The January effect is a lovely concept but is useless when it comes to predicting sharemarket gains and losses.
That may be just as well because in January 2009 we've seen the Australian sharemarket lose 7% so far.
The best performing sector has been healthcare. It's the only sector to have seen a rise and it's up 0.9% so far in 2008.
The worst sector has been information technology followed by the industrial and financial sectors.
So it looks like the theme for the beginning of 2009 is once again defensive sectors such as healthcare, utilities and consumer staples.
The trend has been to limit risk by going for defensive sectors.
One thing is certain. It's going to be another rollercoaster year. That's actually a good thing because an irrational market is the best place to pick up cheap stocks. Just don't expect them to pick up overnight.
As Warren Buffett says:
"Be fearful when others are greedy, and be greedy when others are fearful".
If the whole point of making money is buying low and selling high then I'd rather be buying now rather than at the highs in 2007.
Look for the quality businesses you're happy to pick up at relatively cheap prices and hold them for the long-term.
Julia Lee Equities Analyst Bell Direct
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