Can you rely on the ‘January effect’?

The first month of the year is famous for the ‘January effect’, which describes the tendency of small-cap stocks to outperform large caps, but is the phenomenon breaking down?

Since 1970, the market has seen positive returns in January in 60% of years and has had an average return of 2.1%. From 1984 to 1999, the average FTSE All-Share return in the month was 3.3%; and as can be seen in the accompanying chart, in those 16 years the market only fell twice in January. But after 2000 things changed dramatically.

Since 2000, the average market return in January has been -1.6%, with the market seeing positive returns in only six years – and in four years since 2000 the market has fallen more than 5% in the month. This makes January the worst of all months for shares since 2000.

In an average January, shares usually start trading strongly in the first few days. However, that ebullience soon wears off and prices then slide for the rest of the month, recovering somewhat in the last few days.

The first month of the year is famous for the imaginatively titled ‘January effect’, which describes the tendency of small-cap stocks to outperform large caps in January. This anomaly was first observed in the US, but it applies to the UK market as well. For example, since 1999 the FTSE 250 index outperformed the FTSE 100 index in January in 68% of years, with an average outperformance of 0.6 percentage points. However, it should be noted that the mid-cap index has actually underperformed the large cap index over the last two years, in 2017 and 2018, so the phenomenon might be breaking down.

The FTSE 350 sectors that tend to be strong in January are: healthcare equipment & services, software & computer services, and general industrials; while the weak sectors have been electricity, food producers, and oil & gas producers.

A graph showing the performance of the stock market in January over time

 

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