‘Tis the season for the usual pondering of the turn-of-the-year market trends. A report from the Merrill Lynch Equity and Quantitative Strategy team shows that January has statistically delivered the highest monthly returns and second-highest (after December) frequency of positive returns in all months:
In contrast, a blog post in The Wall Street Journal demonstrates that the December rally is more pronounced and consistent across observation timeframes than the January one, which vanished in the last 20 years:
However, from a monthly peak-close perspective, December is unremarkable, as an article in The Wall Street Journal illustrates:
This finding is less meaningful because it only determines the magnitude of monthly oscillation, rather than a complete return in each month.
According to the post, an interesting return pattern emerges in the last and first month of the year:
A pullback in the middle of December is caused by tax-loss selling by traders, window dressing by fund managers, and portfolio realigning by investors. Once this is over, a rally ensues. However, according to the article, it is statistically significant only in a short period at the turn of the year:
There is one version of the Santa Claus rally that enjoys strong historical support: the last five trading sessions of December and first two of January… Since the Dow was created in 1896, it has gained an average of 1.7% during this seven-trading session period, rising 77% of the time. That is far better than the 0.2% average gain of all other seven-trading-session periods of the calendar.
Here is how the S&P 500® returns look so far this December, as compiled by Alpholio™:
Despite a pullback early in the month, there is some similarity to the above long-term average return pattern. Of course, only time will tell if the rest of the pattern is followed.
The seasonal effects are mostly pronounced in small-cap stocks. In addition, the report claims that lower-quality stocks strongly outperform in January:
Loading up on “junk” equities for the sake of a superior one-month return is probably not advisable. If anything, this might be an opportune time to tilt the portfolio towards high-quality, cash-rich companies, which Merrill Lynch itself recommends in its 2014 outlook. Seasonal market trends, such as the Santa Claus rally or January effect, no matter how likely, should not cloud a long-term investment perspective.