INSIGHTS

On February 02, 2012

The 2012 January Effect?

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With the first month out of the way for 2012, many are commenting on whether the January Effect will carry us through the whole year.  The January Effect has basically two fundamental followers; first that the broad market will show similar returns to what occurred in January and that small caps tend to outperform in January.  There is obviously no way to tell the first component’s accuracy as our “magic 8 ball” keeps telling us to check back later.  However, we can confirm the outperformance of the small cap in the month of January versus large caps.


After underperforming last year compared to large caps, small caps delivered a sizeable outperformance in January.  The Russell 2000 had a 7.00% return in January while the S&P 500 had a respectable 4.35% price return.  In 2012, the small caps underperformed by losing 4.17% in 2011 as compared to a 2.11% total return for the S&P 500.  The bullish case for equities in the month of January is not limited to the United States.  The German DAX index was up 9.50%, the Euro Stoxx was up 4.31%, the Hang Seng was up 10.61% for the month of January and the Nikkei Index was up 4.10% in the month of January.


As we detailed in our Strategic Times: Equity and Real Estate, there are many aspects that are revealing to us that the potential upside in equities is far greater for the next few years than most believe.  One of the many maxims we follow is a reversion to the mean, and for long-term equity bulls, the following chart may be one of the most profound.

Rolling 10 Year Compounded Returns S&P 500



Source: Standard & Poors, Bloomberg


The chart details rolling 10-year total returns in the S&P 500 over the last 85 years.  The timeline on the bottom is the measure of when the 10-year period began.  What we see is that two large cycles have occurred and we are now bouncing off our all-time low.


The one thing all investors have learned over the last few years is that old trading rules don’t necessarily coincide with the new psychological profile of investors.  Although the January effect has shown to be 90+% accurate when just measuring positive returns in January to positive returns in the corresponding year, the validity of this does not offer investors comfort.  In fact, in a time where growth discounts, value-based discounts and strong earnings seem to be in abundance in the equity markets, most investors are still focused on anemic short-term money market fund rates.


We know that markets do not move in a linear fashion, just as the most efficient trails up a mountain side are not straight up; but rather meander.  We do not expect similar monthly returns in the equity markets as January displayed; however, the long-term potential seems far greater than where we are currently.


 

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.