Will the January Effect Hold After a Strong December?

According to the Stock Trader’s Almanac, January is the 4th best month of the year for the Dow Industrials – behind only April, December, and November.

The January Effect often refers to the tendency of stocks (particularly small caps) to rise in January. But with a strong December almost in the books for the Dow (up 5.4%, best since 2003), should investors expect to witness further strength in January?

Perhaps, but there are some mixed results when the Dow has finished up more than 5% in December (that has occurred just 10 times since 1928)…

The good news: In all but 3 of those occasions (or 70% of the time), the Dow has followed up with a gain in January. In contrast, the Dow posts a January gain slightly less frequently (64% of the time) when it does not rise more than 5% in December.

The not-so-good news: When the Dow finishes up more than 5% in December, the average January gain for the Blue Chip index is a meager 0.34%. That’s far below the average January gain of 1.23% when the Dow either declines or posts a gain below 5% in December.

The bad news: So what’s the explanation for the lackluster average gain in January despite the relatively high frequency of gains? During each of the three times the Dow has not gained in January after rising more than 5% in December, the Dow posted fairly significant losses. It fell 4.1% in January 1957 (after rising 5.7% in December 1956), dropped 5.0% in January 1977 (following a 6.1% rise in December 1976), and declined 4.8% in January 2000 (after moving 5.7% higher in December 1999).

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