The strong January observation
US equity markets have started 2018 on a strong note, with the S&P500 up 5.62% for the month of January, representing the largest monthly gain for the S&P500 since March 2016 (+6.6%).
We are interested in seeing if a strong market rally throughout the month of January sets the tone for the year ahead? In other words, does a strong January influence where the S&P500 will finish come the end of December?
For this purpose, we have looked back as far as 1980, representing 38 years. Of those 38, there have been 10 years where the S&P500 has gained 4% or more in the month of January.
Interestingly, in all those years, prices have ended the year higher than where they started, with the average yearly return of 21.35%. This is more than double the average calendar year for the entire period, being 10.08%.
Chart 1 plots the year with a January return of above 4%, with the actual January return plotted in grey, and the subsequent yearly return plotted in orange.
We acknowledge that we have included the January return in the yearly return. If we were to exclude the January return and simply look at the return from February through to December, only 1987 would have yielded a negative return. The average for the remaining 11-month periods remains high at 14.54%.
Chart 1. Years with a January return above 4% compared with overall returns for that year
While there is compelling evidence that a strong return in January leads to a positive result for the year, let's see if this relationship holds for the reverse.
Specifically, if the S&P500 has a weak start to the year, defined as a January return of -4% or less, does that lead to a poor overall year for equities?
Again, using data from 1980, there have been only 6 years starting with a January return worse than -4%, being 1981, 1991, 2000, 2008, 2009, and 2016.
Interestingly, four of these years have ended with a negative yearly return, while 2009 and 2016 ended in positive territory. As shown on chart 2, the average yearly return for the 6 years is -5.32%, considerably below the average of all years of 10.08%.
Even excluding the January figures from the yearly totals, the average return for the remaining 11 months is a meagre 0.98%.
Chart 2 plots the year with a January return of less than -4%, with the actual January return plotted in grey, and the subsequent yearly return plotted in orange.
Chart 2. Years with a January return below 4% compared with overall returns for that year
For the years discussed, the below chart shows the maximum daily drawdown experienced over the year. The maximum drawdown is simply the largest decline, from peak to trough, expressed in percentage terms.
The average maximum drawdown, including 2018 is 11.60%, with 1987 being a notable outlier at 33.46%. The recent decline in the S&P500 that we have witnessed over the past 2 weeks, has been 10.09% to date.
While 2018 is yet to conclude, a decline in the vicinity of 10% appears to be the norm for those years showing a January return greater than 4%.
Chart 3. Maximum daily drawdown between 1980 and 2018
Overall, it seems that a large return in January, whether that be positive or negative, is a decent predictor of the type of year that follows.
While there are many factors that will come into play in determining how 2018 will unfold, one positive is the strong month of January.
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*Please note this article is purely observational, and past performance is no guide to future performance.