Weird, Wonderful, or Absurd: Cyclical Effects on Markets

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Most of us who make our livings watching the financial markets are aware of a phenomenon that is strange, but interesting. For reasons that may make sense – or make no sense whatsoever – a mythology has developed about certain trends or cycles that can affect market performance.

Oddly enough, some of these weird myths about the stock market seem to be mostly true! One is the so-called “January Effect.” Others, like the Super Bowl, the Presidential election, etc., are in the same category: weird, but true. Whether they are a sound basis for investment decision, of course, is another question.

And then there are plenty of other supposed cyclical effects that don’t hold up at all on close examination.

So why would investors trust something that seems like so much crystal-ball gazing or tea-leaf reading?

Because so much uncertainty encircles the investment process, investors will often grasp at something that appears to be solid.  The “January Effect” is one example of these “somethings.”  Simply put, the January Effect is the notion that the market usually rises in the month of January and that a good market performance in January bodes well for the entire year.  Over the last 60 years, when January logged a positive performance, the market was higher for the full year about 90% of the time.  When the market fell in January, the full year showed a negative return about 55% of the time.

There may be some basis for this, at least for the rising markets in the year’s first month. An analysis in “The Wall Street Journal” said so-called “tax loss selling” may explain much of the January effect. Investors seeking to minimize their tax burden will sell off securities that have underperformed. This can tend to artificially drive down those stocks’ prices in late December. But come January, the pressure to harvest losses to offset taxable gains disappears. And so, those prices tend to recover.

The January effect is most pronounced among small-cap stocks, the “Journal” article said, as well as with issues that are held more by individuals – motivated by tax considerations – than by institutional investors. Another factor that some analysts have seen is that the January effect is greater in years that tax rates decline. That’s because investors are more inclined to take advantage of offsetting losses under the prior year’s higher tax rates.

A similar phenomenon, but one without any actual connection to market activity, is the “Super Bowl Effect.”  More often than not, the stock market rises in the years when a team from the old National Football League (now the NFC) wins the Super Bowl. Hence, equity investors may have had another reason to cheer for the Atlanta Falcons this year. Sadly for those who believe in this notion, of course, the New England Patriots won this year, which should portend an off year for stocks.

According to an article in MarketWatch, this indicator has been right 40 of the 50 years the Super Bowl has been played. That 80% success rate is pretty astonishing in the world of market predictions, though it has not been quite so impressive in the last several years. The ratio of “correct” results since 2000 has been only 70%. MarketWatch editor Mike Murphy noted, “After being correct seven years in a row, 2016 defied the prognostication — the AFC’s Denver Broncos won the Super Bowl, but the stock market posted a yearly gain.”

Other “somethings” out there include the “Presidential Year Effect,” the “Halloween Indicator,” the “Mark Twain” effect, and so forth. All these observations are simple attempts to bring more certainty to the stock market.  And all these things are also totally absurd. Fun, perhaps, but absurd.

They are classic examples of “correlation without causation.” Just because two unrelated factors occur at the same time, one does not necessarily cause the other. The rooster’s crowing may be highly correlated with the rising sun, but the bird’s cry does not cause the sun to rise. Every year ice cream sales and accidental drownings show a remarkable correlation. Does eating ice cream cause drowning? Clearly not, but both tend to rise during the summer months.

The point is this: While these supposed effects are entertaining and sometimes mystifying, they aren’t a good basis for making decisions with your investments to buy, sell, or hold. There is no real substitute for keeping a careful eye on broader trends involving the market, the national and world economies, and what’s happening in specific industries or individual companies.

All that is hard work and time-consuming, of course. Which is why most investors do well working with experienced advisors who make it their business to understand actual economic trends. The mystical mumbo-jumbo is fun to talk about at parties, but not a good basis for making decisions about your nest egg.

 

Old North State Trust, LLC (ONST) periodically produces publications as a service to clients and friends.  The information contained in these publications is intended to provide general information about issues related to trust, investment and estate related topics.  Readers should be aware that the facts may vary depending upon individual circumstances.  The information contained in these publications is intended solely for informational purposes, is proprietary to ONST and is not guaranteed to be accurate, complete or timely.