January Effect?

Urban legends are rampant in the investing world, one of them is the January Effect.  The idea that stocks often rally in January following tax loss selling in December, as well as the idea that a good January will signal a good year.  There is little data to back these myths up but they persist – one of the tenants of behavioral investing is that people like to see patterns where none exist.

Looking at the markets today, there is little economic data to make one believe we should see a sustainable market rally.  As mentioned in a recent post, steel production could be used as a good barometer of economic activity right now and the news there is bleak.  The steel industry, like so many others, sees government stimulus as their only short-term hope.

Steel production is merely part of the larger story, as global manufacturing has now experienced is largest slowdown in decades, as covered in NYT, WSJ, and FT.  The story is much the same around the world.

Nevertheless, the markets could see a rally in the short term.  Institutional investors are hopeful that global governmental stimulus packages will have an impact and may attempt to time the bottom in anticipation of those packages being implemented.  These investors have a large amount of cash on hand from their massive selling in the second half of 2008 and may be tempted to put some of it to work in anticipation of a market rebound.

I believe, however, that any rally will be short-lived as the economic news remains discouraging and the huge amount of deleveraging that still needs to be done works its way through the system.  Many institutional investors will see any rally as an opportunity to sell as they continue to raise the cash they need to repair balance sheets and satisfy forced redemptions.

Further, there is a lot of jockeying remaining to be done on the stimulus package here in the US.  The news today is that the republicans are threatening to delay any package, and the democrats are hardly united in what they want.

Remember that only a few days ago the IMF called for global government stimulus or face the prospect of global depression.

Remember also that during the past 20 years Japan’s stock market has had rallies of 20% or more at some point nearly every year, only to subsequently fall to new lows.

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