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John Dorfman
John Dorfman
Articles (221)  | Author's Website |

The January Effect Is Alive and Well in 2021

So far, this January looks the way Wall Street folklore says it should

So far, this January looks the way Wall Street folklore says it should.

Stock traders talk about the "January effect" and the "January barometer." The January effect is actually a confluence of three effects. The market in general tends to rise in January. Small stocks usually do better than large, and last year's losers often rebound.

The January barometer is the belief that the first month of the year predicts how the market will fare for the year as a whole.

A year ago, the market acted as if it had never heard of the January effect. None of the three parts of the effect occurred in January 2020. The market fell, small stocks did worse and the winners of 2019 kept up their victory dance while the losers kept suffering.

The January barometer also flopped last year. The market fell a little in January and plunged in February and March as the pandemic worsened. And yet, U.S. stocks (as measured by the Standard & Poor's 500 Index) returned 18.40% for the full calendar year.

On script

So far this year, the market seems to have read the January script and memorized its lines.

The S&P 500 is up 2.4%. Traders believe that within six to nine months, restaurants will be open, theme parks and theaters will be crowded and planes and cruise ships will no longer be deserted.

Small stocks, gauged by the Russell 200 Index, are romping, up 9.8%. This gives me particular pleasure since one of my favorite pastimes is finding smaller, off-the-beaten-path stocks.

Finally, for the most part, last year's losers are coming back. In particular, oil and gas stocks, which were pummeled in 2020, are roaring.

Here's how some sad sacks of 2020 are doing so far in 2021:

  • Occidental Petroleum Corp. (NYSE:OXY), down a sickening 55% last year, is up 24%.
  • Continental Resources Inc. (NYSE:CLR), which dropped 52% last year, has returned 17%.
  • Gannett Co. Inc. (NYSE:GCI), the newspaper chair whose stock fell 47% in 2020, has rebounded 25%.

By no means have all of last year's losers bounced back, however.

My mini-survey included 10 stocks that fell heavily in 2020: the three above, plus AMC Entertainment Holdings Inc. (NYSE:AMC), American Airlines Group Inc. (NASDAQ:AAL), Carnival Corp. (NYSE:CCL), Groupon Inc. (NASDAQ:GRPN), Marathon Oil Corp. (NYSE:MRO), Norwegian Cruise Lines Holdings Ltd. (NYSE:NCLH) and Vornado Realty Trust (NYSE:VNO).

On average, these 10 calamities from 2020 had gained 13%from the start of this year through Jan. 22. Three of the 10 were energy-industry stocks, and they provided the biggest share of the oomph.

Even without the three energy names, however, this basket of 2020 losers had gained about 6%.

Three of the 10 losers have ebbed further in 2021 to date: Carnival, Groupon and Norwegian Cruise Lines.

AMC Entertainment, the movie-theatre chain, has jumped 65% so far this year, but it slid 70% last year. Remember, as your eighth-grade math teacher probably drummed into you, it takes a 233% gain to erase a 70% loss.

The barometer

So much for the January effect. Now, what about the January barometer?

If the 2.4% gain through Friday, Jan. 22 holds up for another few days, the January barometer theory predicts that 2021 will be a good year.

That's heartening, if you believe the theory. My research, however, suggests that the January barometer is a busted instrument.

I've studied the performance of the barometer for a 71-year period, from 1950 through 2020 inclusive. In its basic form, the barometer has been right 55 times, or 77.5% of the time.

That sounds not so bad, right? But it is. A naïve forecasting model, which predicts that every year will be up, has been right 78.9% of the time, a percentage point better than the vaunted barometer.

In addition, remember that January is part of the year it is supposed to predict. So a more interesting question may be whether January predicts the following 11 months. On that slightly harder test, the effectiveness of the barometer drops to 67.6%.

Presumably, one purpose of a barometer is to warn of foul weather ahead. So an important question is: How does the barometer do in years when the market is down? In that situation, it makes correct predictions only 44.4% of the time.

So this is one piece of Wall Street lore that I don't think is very useful. Nonetheless, I'm glad that 2021 is starting off on a positive note, and I hope it finishes that way.

Disclosure: A private partnership I manage holds call options on Continental Resources.

John Dorfman is chairman of Dorfman Value Investments LLC in Boston, Massachusetts, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at [email protected].

About the author:

John Dorfman
John Dorfman founded Dorfman Value Investments in 1999. Previously he was a Senior Special Writer for The Wall Street Journal, executive editor of Consumer Reports, and a managing director at Dreman Value Management. His syndicated column appears on Tuesdays on this website and also in the Pittsburgh Tribune Review, Ohio.com, Virginian Pilot and Omaha World Herald.

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