This once seemingly robust indicator has deteriorated over time into little more than a coin toss, says Brendan McCurdy - so serving as a cautionary tale on any seemingly attractive trend or trading strategy
Investors watching major stock indices levitate early in 2017 might have been reminded of the old trader's adage: "As goes January, so goes the year." We think one adage deserves another - so here goes: "There are lies, damned lies, and statistics."
Recent history suggests early-year performance is little more than a coin-flip in terms of predictive power for returns the rest of the year. To be sure, the statistics behind the so-called ‘January barometer' can, at first glance, appear compelling - depending on timeframes and index choice, the historical success ratio can be north of 90%.
We tested the idea out on indices besides the S&P 500 index, on which claims of the barometer's efficacy are often based. As it turns out, the effect is not very prevalent in developed markets outside of the US. Moreover, since 2000, its likelihood of success has been dwindling.
We specifically examined the UK's FTSE All-Share, plus indices for France, Italy and Japan (the Nikkei 225). Starting with the earliest common inception of 1974, the January barometer worked well in the US over this long timeframe - 70% of the time for the S&P 500 over 43 years, and 77% when ignoring relatively flat years (-4% to +4% annual return).
Figures were similar for the FTSE All-Share (76%, subtracting flat return years); Italy (74%); and Japan (69%). Only France - at 62% - was somewhat disappointing.
But here's the problem - the maxim has failed more often in recent years. Wider recognition of the January phenomenon may well have been its undoing. In fact, the turn of the millennium seems to have been a major (negative) inflection point.
Since the year 2000, the annual return in each market has moved in January's direction barely half the time - even when accounting for flat-return years. Furthermore, the years in which the barometer failed correlate more highly with one another of these indices since 2000.
A seemingly robust indicator has deteriorated over time into a coin toss - a point, we believe, that is worth stressing. Investors generally do not perceive their portfolios as an appropriate venue for a 50/50 coin-flip of gains or losses, outperformance or underperformance.
Indeed, the discipline of behavioural finance includes the term ‘loss aversion' to express an individual's tendency to prefer avoiding losses rather than accruing gains. According to analysis conducted in Choices, Values, and Frames by Daniel Kahneman and Amos Tversky, the typical investor dislikes losses roughly three times as much as they love gains.
As a result, for the financial adviser charged with client assets, there is a very real business risk in taking any sort of tactical tilt that does not have a high probability of success. This observation is a useful one to keep in mind when learning of a seemingly attractive trend or trading strategy. If there is not a very clear and compelling intuitive case for the pattern, beware.
Brendan McCurdy is a vice president at Goldman Sachs Asset Management, leading the firm's Europe and Middle East Portfolio Strategy team of Strategic Advisory Solutions
After 20 years in Westminster
Retired in 2014
Dividend tax hike also stayed
Advisers lacking knowledge
Five short video interviews with RLAM’s head of multi-asset