Forget the ‘Santa Rally’, the stock market could be set to benefit from the ‘January Effect’.
As much as I love these catchy market aphorisms, they’re not a good basis for an investment strategy. Yet commentators have been lining up to predict good times ahead for the market in 2024. And if they prove to be correct, January could easily deliver a market rally.
As in January, so the year ahead?
The January Effect refers to the observation that the stock market often experiences a seasonal increase in stock prices during the first month of a new year.
However, over the past 30 years, the markets have rallied in January around 57% of the time and declined 43% of the time. So the historical data isn’t convincing.
Nevertheless, part of any January Effect is likely to be a continuation of the Santa Claus Rally. A chap called Yale Hirsch coined the term in 1972. He defined the timeframe for the Santa Clause Rally as the final five trading days of the year and the first two trading days of the following year.
If there is a rally because of the January Effect, it’s possible The January Barometer will kick in! That one was also started off by Hirsch. He wrote a novel published in 1969 called Stock Trader’s Almanac.
The idea presented in the book is that the performance of America’s S&P 500 index in January tends to predict its trajectory for the whole year. The read-across is that if the US market does well, the UK will likely follow.
These stock market sayings are often flawed and contradictory though. If we have a rally in January and it predicts a bull market for the year, should I still ‘Sell in May and go away, come back on St Leger’s Day’?
If I did that, half the likely rally in stocks would be missed. It’s all a load of nonsense and akin to trying to read the tealeaves in the bottom of a cup.
Business picking, not stocks
A better way to proceed with stocks and shares is to focus on the underlying businesses. The father of value investing – Benjamin Graham – said the stock market is a voting machine in the short term but a weighing machine in the long term.
In other words, stock prices can be all over the place for periods of time driven by the ebbs and flows of investor sentiment. But in the long run, it’s the progress of underlying businesses that drive the direction of share prices.
If a company’s earnings move higher for, say, 10 years, the share price will likely rise in the end just to maintain the original valuation. For example, to keep the price-to-earnings ratio as it was before earnings improved.
That’s the weighing machine in operation. But it can get even better. If growth in earnings accelerates, valuations can increase. Perhaps from an earnings multiple of 10-15. And that’s another often powerful long-term share-price driver.
Positive investment outcomes are never guaranteed. But the lesson is clear for me. Instead of chasing Santa Rallies and January Effects, I’m working hard on my watchlist ready to buy shares in great businesses at opportune times.
