January Effect found wanting

The effectiveness of a well-known method used by Wall St brokers to predict stockmarket performance is being questioned by two Massey University researchers.

The method, known as the January Barometer or Other January Effect, suggests stockmarket performance during the first month of the year mirrors how the next 11 months will play out.

In other words, a bullish January heralds a positive 11 months in the market, or vice versa after a negative start to the year.

Ben Marshall, one of two Massey academics to do research on the subject, said he did not disagree with January sometimes being an indicator month, but questioned its ability to deliver significant financial gains.

Marshall said the Massey study, which analysed the performance of a number of stock exchanges from 1940 until 2008, compared the returns an investor would receive using the barometer theory - jumping in and out of the market - or a "buy-and-hold" approach.

"Somebody who took a buy-and-hold approach would have outperformed somebody who was chopping in and out of the market depending on how January was," he said.

This was because after a weak January in the market, returns for the next 11 months would not actually be negative, just less than they would be after a positive start to the year.

Marshall said an investor who opted out of the market because of a negative January would therefore miss out on those, admittedly smaller, returns.

The study concluded that the barometer was not a useful tool for investors, and could not be used to earn economically significant returns.

Dr Nuttawat Visaltanachoti, the other academic who took part in the study, said: "If the Other January Effect does not generate economic profits, then those currently using the Other January Effect should reconsider their faith in using this timing tool."

The January Barometer theory had received more attention in the United States than in New Zealand, Marshall said, and had been the subject of many articles in the American financial press.

James Smalley, a client adviser at broking firm Hamilton Hindin Greene, had not heard of the January Barometer being widely used by New Zealand brokers and investors.

Finding a way to predict stockmarket performance was the holy grail, he said.

But even if a method was found, Smalley said, it would "cancel itself out" once the idea spread through the market, forcing investors to buy stock simultaneously, pushing prices up.

"It's almost like chasing the pot of gold at the end of the rainbow - you get [to the end of the rainbow] and it isn't there."

Marshall said January could act as a market barometer because it was a month that was more often bullish than bearish.

Marshall and Visaltanachoti's paper - The Other January Effect: Evidence against market efficiency - will be published by the Journal of Banking and Finance next month.