THE JANUARY EFFECT

ARTICLE

THE JANUARY EFFECT

By Peter De Coensel,
DPAM CEO

The 2023 January effect has been stellar and confirmed! Wikipedia explains as follows:

“The January effect is a hypothesis that there is a seasonal anomaly in the financial market where securities’ prices increase in the month of January more than in any other month. This calendar effect would create an opportunity for investors to buy stocks for lower prices before January and sell them after their value increases. As with all calendar effects, if true, it would suggest that the market is not efficient, as market efficiency would suggest that this effect should disappear.
The effect was first observed around 1942 by investment banker Sidney B. Wachtel, who noted that since 1925, small stocks had outperformed the broader market in January, with most of the disparity occurring before the middle of the month. It has also been noted that when combined with the four-year US presidential cycle, historically the largest January effect occurs in the third year of a president’s term.”

January 2023 ticks most boxes, including a surprising one that it is strongest in the third year of a president’s term. Interestingly, the effect only has equities in scope. Yet, over the past 4 weeks, both fixed income and equity markets have seen markedly positive outcomes. It’s all about the price and the level at which one locks in future cash flow streams. In December, there was a brutal broad-based market sell-off across equity and bond sectors, leading to a perfect set-up for a January market rally. The table with expected return estimates across bond sectors at the end of 2022 speaks volumes, with returns moving from the 10th percentile of richest readings towards the 70-80th percentile of most attractive valuations over the past 20 years in just 12 months.

Figure 1: Expected returns – breakdown

Source: DPAM 31.12.2022

Early in the year, the Bank of America market barometer flashed extreme bearishness across sell-side market strategists. However, CTA’s (Commodity Trading Advisors, the hedge fund community assembling a wide range of, derivates-based, systematic trading or trend following strategies) started 2023 with bullish equity positioning. This community has been unnerving the buy-side equity and fixed income investor base. Might the January effect transform in the January barometer effect i.e. that a positive first month of the year will translate into a positive 2023? Proponents of this view can rely on data showing that the January Barometer has registered only 11 errors between 1950 and 2021. The indicator has an accuracy ratio of 84.5%. Yet, this barometer is only associated with the US S&P 500 stock index.

Let’s dig into performances so far. The MSCI Europe Net Total Return index sits at +7.21% YtD after a difficult December reading at -3.51%. Over 2022, the drawdown stood at -9.49% versus a QE-supported 2021 at +25.13%. Perspective is required once in a while. Over the past 10 years, this main European index advanced at an +7.24% annualized pace. It is sobering to acknowledge that over that period, the annualized total return on European Government bonds comes in at a mere +1.26%. The European investment grade corporate bond universe puts in a +1.11% between January 28th 2013 and January 27th 2023 given a lower average maturity, hence duration, for the IG sector compared to the Government Bond sector. For reference, the S&P 500 total return index expressed in EUR delivers an annualized +15.05% over the past 10 years (+12.59% in USD). The Nasdaq 100 total return index in EUR over the past 10 years accrued at an impressive+20.00% annualized.

The Bloomberg Barclays Global Aggregate Total Return index posted a 2.35% annualized EUR return over the past 10 years. Meanwhile, the European High Yield index delivered +3.40% annualized. Euro–centric investors saw a gross equity risk premium of about 6% compared to European Government and IG Corporate bonds.

As January nears its end, fixed income expected return estimates have adjusted about 40bp to 50bp lower. Still, compared to the past decade, they still offer above-average income expectations. The moment the FED finishes their hiking cycle in Q2 2023, one can expect that specific EM central banks start to ease monetary policy. Another wall of worry might have to be climbed as interest in the EM bond sector has been anaemic over the past years.

The equity risk premium has flipped from attractive to slightly expensive in the past year as fixed income competition became stiff. Taking expected nominal returns on US Treasuries, the US ERP fluctuates around 3.00%. A look at weekly updates of year-over-year S&P 500 forecasted earnings growth by quarter reveals that earnings expectations for Q4 2022 through Q2 2023 are negative at -3.10% (Q4 2022), -2.04% (Q1 2023) and -3.10% (Q2 2023) respectively. Q3 2023 flips positive at +3.71% and by Q4 2023 earnings should grow by 9.25%. Clearly a FED pivot and first set of rate cuts are the market base case scenario by Q4 2023.

The strong January effect on top of a January barometer fear of missing out (FOMO) might send us in a positive feedback loop over the short-term. Full reopening of the Chinese economy and improving global growth estimates might lift animal spirits. Historically, risk markets have exhibited highly positive outcomes over the 24 months after the terminal policy rate has been reached. Inflation is trending towards its target. The known unknown factor is the Russian-Ukraine war and whether the Russian presidential elections in March 2024 will increase the chances of a truce in the next 6 months.

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THE JANUARY EFFECT