“… So goes the year” is one of those old “Wall Street wisdom” sound bites. The theory is that when January culminates in good stock market performance, so will the entire year. In fact, about 86% of the time since 1945, a good January has led to a good year: the average return for the S&P in such years is 14%.
This January, the S&P closed with a return of about 4.48%. That’s better than all of last year. Does this mean stocks will do well this year? We take the old saying with a grain of salt – actually a whole shaker. We’re dubious for several reasons:
- First of all, it doesn’t always work. About 14% of the time, stocks do poorly despite a positive January. And there’s no way to tell which year you’re in: one of the 86 out of 100, or one of the 14.
- Second, other seasonal and cyclical phenomenon affect stock returns. For instance, the market usually performs well in an election year. So if this year is decent, will that be because of the election cycle, or the January effect?
- Third, there have been only 66 January’s since 1945 (not including 2012 which isn’t in the statistics yet). This is a pretty small sample size. Statisticians would say this isn’t enough observations to result in a statistically significant result.
We think valuation is the best forward predictor of returns. The lower the price you pay for assets, earnings, and dividends, the more likely it is that you will make money, and vice versa. For instance, if you buy a rental house for $75,000 and it generates $1,000 per month in rent, you’ll have a great return right off the bat. But if you have to pay $150,000 for that same rental house, you’ll have to wait to raise rents before you match the return of the house at a cheaper price.
Stocks are cheap right now, with PE ratios relatively low and dividend yields rising steadily. Of course, stocks have been cheap for a while, and we still haven’t broken out of a decade long trading range, so if the January effect comes true, it won’t hurt our feelings at all.