Financial Professionals

Market Insights

A A A

As January goes, so goes the year?

01/15/2014

With the start of a new year, we expect an onslaught of “as goes January, so goes the year” posts. It is fitting, then, to revisit a blog we wrote on this topic in January of last year.

As January goes, so goes the year?

Excerpt from the original blog posted on the Newfound Research site in January 2013, using data from 1950 to 2012.

At Newfound, we are strong proponents of rules-based investing. However, rules-based investing in and of itself is not a panacea. The best rules will be defensible both in theory and in practice and be robust to dynamic market environments.

The following table shows for each month the percentage of times that the sign of that month’s S&P 500® return matched the sign of the return for the period starting in the beginning of that month and ending one year later.

For example, the January figure means that starting in 1950, 69.8% of the time the sign of the return from January 1 to February 1 of that year matched the sign of the return from January 1 of that year to January 1 of the next year.

Month

Percent

January

69.8%

February

63.5%

March

73.0%

April

58.7%

May

65.1%

June

61.9%

July

54.0%

August

55.6%

September

52.4%

October

65.1%

November

65.1%

December

76.2%

Source: Newfound Research LLC

What can we learn from this data? March and December returns seem to have done a better job than January’s returns in predicting the return for the following one-year period. However, we need to dig deeper to see if these statistics are meaningful both in theory and in practice.

From a theoretical perspective, if we make some simplifying assumptions about the distribution of S&P 500 returns, then we can explicitly compute the values in the above table. For the following discussion, we assume:

  • Returns are normally distributed
  • Monthly returns are i.i.d. (the distribution of each monthly return is identical and the return in one month does not affect the returns of subsequent months)
  • Annual S&P 500 return has a mean of 7% and volatility of 15%

If January’s return is very slightly positive, the probability of a positive annual return is 67.2%. If January’s return is 2.0%, the probability of a positive annual return increases to 72.1%. If January’s return is 5.0%, the probability of a positive annual return increases further to 78.7%.

The chart below shows the probability of a positive annual return given various January returns.

Source: Newfound Research LLC

This illustrates that the historical data backing the heuristic that “as goes January, so goes the year” is an expected statistical artifact and provides no basis for generating value as an investment strategy. Strong market performance in January does not cause strong market performance in the following eleven months. Instead, strong market performance in January simply makes it more likely that the full 12-month return is positive in the same way that the team winning a football game at the end of the third quarter has a better chance of winning the game. Strong January returns give the full year return a head start, providing no forward looking information that can be used to trade profitably.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.