Most of us who make a living watching the financial markets are aware of a strange, but interesting, phenomenon. For reasons that may make sense – or none 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 and Presidential election, are in the same category of 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?
It’s because with so much uncertainty encircling the investment process, investors will often grasp at something that appears to be solid. Take the “January Effect,” for example. Simply put, it is the notion that the market usually rises in the month of January and 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 percent of the time. When the market fell in January, the full year showed a negative return about 55 percent 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 concludes that “tax loss selling” may explain much of the effect. Investors seeking to minimize their tax burden will sell off securities that have underperformed. This can artificially drive down those stock prices in late December. But come January, the pressure to harvest losses to offset taxable gains disappears, 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 held more by individuals motivated by tax considerations than by institutional investors. Another factor some analysts have seen is the January Effect is greater in years when 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 percent 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 percent.
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” and the “Mark Twain Effect.” All these observations are simple attempts to bring more certainty into the stock market. And they’re totally absurd. Fun, perhaps, but absurd.
They are classic examples of correlation without causation. Just because two unrelated factors occur at the same time, doesn’t mean one necessarily causes 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 buy, sell or hold decisions with your investments. 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.
Susan Willett is the director of trust services and oversees all aspects of trust administration for Old North State Trust, LLC. Old North State Trust, a North Carolina chartered trust company, provides: asset management services; income, estate and trust tax consulting; retirement planning and administration; and trustee and estate services to both individuals and businesses. Old North State Trust professionals have many years of experience and for over a decade have assisted clients in identifying and reaching their financial goals. For more information, visit www.oldnorthstatetrust.com or call 910-399-5470.
Cece Nunn - Nov 30, 2020
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