Starting Off the Year Right

January 12, 2018 James Virgo

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With the holiday season behind us, it’s that time of the year where I turn my attention to two things: losing the 10 pounds of holiday weight I’ve gained and looking for signs in equity markets to see what’s in store for 2018. The first will come with healthier dietary choices and getting back to regular exercise (albeit slower than I would like), but figuring out what equity markets will do this year is a tad bit more complicated.

A positive start to 2018… so far

Markets are off to a good start, especially outside of Canada—for the first five trading days of 2018, the S&P/TSX Capped Composite Index (+0.67%), the S&P 500 Index (+2.77%), the Dow Jones Industrial Average Index (+2.28%) and the MSCI EAFE Index (+2.35%) are all trading positively.

Many people attempt to find patterns, particularly when trying to predict equity market returns. To do so, they look to things like the January Effect—an increase in stock prices during the month of January. This historical trend, first noticed in the 1940’s, is generally attributed to an increase in investment purchasing right at the beginning of the year.

The bump in buying could be repurchases by investors engaged in tax-loss strategies (selling investments at a loss before the end of the year to offset realized capital gains). Another reason could be investors using their annual bonuses to purchase investments. There are psychological contributors as well: January is a reference starting point and the ever popular New Year’s resolutions. The truth is likely a combination of these and other factors.

It appears the January Effect is in full effect.

So we’ve started strong, what does it mean for the rest of the year?

Many have used equity market performance in January to gauge how the rest of the year will go. These momentum based theories aim to establish a market trend and suggest you can capitalize on its continuation.

The Santa Claus Rally looks at the trading days after Christmas through the second day of trading in January. The saying goes “If Santa should fail to call, bears may come to Broad and Wall.”

Some believe the first day of January will foretell the market’s direction for the rest of the year. Similarly, some look at the first five trading days and others, the entire month of January. “As goes January, so goes the year.”

Surprisingly, since 1929, January has successfully predicted the performance of the S&P 500 73% of the time!

However, if we look closely at the S&P 500 over the last 10 years, the January Effect did not happen in six of those years (’08, ’09, ’10, ’14, ’15, ’16) and January was wrong—quite dramatically—in four of those years at forecasting the rest of the year (’09, ’10, ’14, ’16).

While it’s amusing to look at the January Effect and to use January to predict market performance, it’s clear these are not good indicators to solely base your investment strategy on.

It takes more than a month to position your portfolio

It’s not as simple as looking at one or two indictors at one point in time. As part of our investment process at MD, we look at momentum as well as many other economic and market indicators on an ongoing basis. As my colleague Patrick Ercolano wrote last week, we are feeling pretty confident in global markets going into 2018, but for reasons far more robust than January performance.

We continue to believe equities will outperform fixed income and are positioned accordingly. Our equity portfolios are generally more defensive at this time—higher quality, lower volatility, with reasonable valuations—to be ready for a market pull back if it were to materialize. On the fixed income side, we continue to position to enhance yield and preserve capital. 

I’ll take a Santa Claus Rally, a positive first trading week, and hopefully a positive first month. But we’ll continue to watch economic growth, corporate earnings, inflation, interest rates and more to determine our next steps. Join me in eating healthy, exercising regularly and following a disciplined investment strategy for 2018.

 

About the Author

James Virgo, CFA, CFP, MBA, is Vice President and National Lead with MD Private Investment Counsel at MD Financial Management. He oversees the practice of investment counselling and delivery of investment advice across MD PIC.

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