The Nonsensical January Effect – Explained

Gong Xi Fa Cai, everyone! The Chinese Spring Festival can mean different things to different people. For some, it is chance to share some of the prosperity that they have accumulated over the year by distributing it to the young in the form of Red Packets.

For others it could be an opportunity to renew relationships with old friends and members of family, whom they might not have seen during the busy Year of the Ram. As for me, it means all of those things. But it also reminds me of something else – fish. Yes, fish.

For me the fish is not just a symbol of life. It reminds me of something that happened many years ago, when a friend asked me to help him move his indoor aquarium in preparation for the Lunar New Year.

My friend had quite an magnificent fish tank in which he stocks his colourful, exotic, and no doubt very expensive, aquatic specimens. Thankfully, for the both of our backs, he had done most of the hard work even before I arrived by relocating the livestock to a safer place.

But instead of emptying out all the water from the tank, he only removed just enough water so that the two of us could lift and move the tank without too much effort. There was, I should point out, still lots of water left in the tank.

As we carefully made our way from one end of the room to the other, we had overlooked something that any self-respecting schoolboy would have known – inertia.

We had forgotten that whilst we could move the tank with relative ease, the water preferred to stay where it was. Consequently, the water in the tank would thrash violently from one side to the other, which resulted in massive puddles on the floor.

It was not a pleasant sight. But what, you may ask, has this got to do with investing. It has lots to do with investing.

The buffeting of the water from one side of the tank to the other is analogous to the volumes of cash that come and go from the markets. At one moment in time, traders who might believe that stocks are better than bonds will waste no time in ditching their fixed-income investments for shares.

They could even shift their investments from one side of the globe to the other. And should they reckon that property could be more attractive, they could, with the click of a button, swap their shares for bricks and mortar.

The constant flitting from one asset class to another can result in the kind of massive swings in asset prices that we have witnessed since the start of 2016. But volatility is nothing new.

That said, it has probably been greatly amplified by the vast quantities of money that central banks have magicked out of thin air and handed to investment and retail bankers to do as they wish.

But we should not be swayed, guided or even misled by the fickle flow of money in and out of various investments. Instead, we should stick to the tried and tested method of simply buying good shares in good companies when prices are good, and to stay invested in them, as long as they remain good companies.

Prices may rise and fall, but it is important to remember that the intrinsic values of companies do not gyrate with the whims of the market. As legendary investor Peter Lynch once said: “A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.

The volatility that led to a loss in the stock markets in January has prompted some to resuscitate the old adage, which claims that where January goes, so goes the year.

They claim that since shares fell in January, then the stock market would end the year lower too. If only investing was that easy.

Since 1987, the Straits Times Index (SGX: ^STI) has started off on the wrong foot in the month of January on 11 separate occasions.

In five of those years, the index did finish the year lower. But it ended the year higher on six other occasions.

In other words, using the January effect to determine the outcome for the year is no better than a coin-toss. If anything it is probably slightly worse.

That is not to say that 2016 will definitely be a good year for the stock market.

Much will depend on the market’s ability to rid its attachment and fixation with oil prices and focus instead on corporate results. Its fixation with recent events happened with the Greek debit crisis. (Does anyone even mention Grexit, anymore?)

They will do it again with oil. So ignore the volatility and stick around for the long-term returns. It is a much more productive way to invest.

A version of this article first appeared in The Straits Times.

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