The predictive power of U.S. financial market returns in January for market performance the rest of the year has long been lore on Wall Street. Given the tumultuous start to 2008, investors may want to consider recent research by a professor from the Vanderbilt Owen Graduate School of Management that finally puts some real evidence behind the legendary “January Barometer.” The forecast: a tough year ahead.
Owen Professor Alexei Ovtchinnikov (along with Michael Cooper of the University of Utah and John McConnell of Purdue University) examined stock returns from 1940 to 2003 and found that January returns are a strong and remarkably consistent predictor of market returns over the following 11 months. “On average, a positive January return resulted in a value-weighted return of 14.8 percent for the remainder of the year, while a negative January return led to an average yearly return of 2.92 percent,” said Ovtchinnikov, assistant professor of management at Owen.
These returns were found to be consistent across the spectrum of large- and small-cap stocks and for firms with both high (i.e., value stocks) and low (i.e., growth stocks) book-to-market equity ratios. This finding dispels the notion that the January Barometer – also known as the “Other January Effect” – is largely a reflection of cyclical variations in the returns of “riskier” stocks.
The study’s results held true even after controlling for varied macroeconomic or business cycle variables that have been shown in other research to predict stock returns. These factors included years when a Presidential election campaign takes place and the impact of “investor sentiment” on market returns.
“Based on what we’ve seen thus far in January, the historical precedent seems to indicate that the remainder of the year could be a challenging environment for investment,” said Ovtchinnikov. He acknowledged that the analysis does not fully explain the forces behind the January Barometer. What is clear, however, is that the findings can have important implications for investors, providing valuable information for developing strategies to hedge risks.
Ovtchinnikov’s paper, entitled “The Other January Effect,” was completed while on the faculty at Virginia Tech and appeared in the November 2006 edition of the Journal of Financial Economics.
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