From the year-end rally to the “January effect”

Probably the best known seasonal stock market pattern is the year-end rally.Stock Snap from Pixabay

Farmers and investors are more similar than one might think at first glance. Both want to reap, both of which are seasonal, and farmers and investors alike have devised a number of rules to accommodate this. “A wet May brings milk,” says the dairy farmer. With a stock market professional it sounds like this: “Sell in may and go away”. Or also: “As goes january, so goes the year” – whereas the farmer knows: “January cold and rough uses the grain cultivation.”

Similar to farmer rules, statements on the seasonality of the stock exchanges are mostly based on observation and experience, so they are not completely out of thin air. For example, the May sales recommendation is said to be based on the fact that the upper class once said goodbye to the summer resort in late spring (and had neither computers nor internet available there), so that there was a temporary lull on the stock exchanges. Investors should not blindly follow supposedly clear seasonal patterns, like farmers’ rules. Because that can go in the eye.

Probably the best known seasonal stock market pattern is the year-end rally. Towards the end of the year, so the theory goes, share prices will rise again strongly. Indeed, this effect can be observed in many markets and over many years. If you look at the development of the Dax over the past few decades, you will notice that the German benchmark index has risen disproportionately often in the last three months of the year. Stock market experts see several possible reasons for this: Many fund managers want to quickly spruce up their portfolios in the fourth quarter and buy the year’s winning shares. It is also conceivable that investors in the pre-Christmas shopping mood will increasingly go on a shopping spree.

Statistically, many stock indices also have a strong start to the year. Stock market professionals speak of the “January effect”. The fact that returns in the first month of the year are often above average is probably due to tax reasons: towards the end of the year, many investors sell stocks that have done badly in order to realize losses and thus save taxes. In January they will access the stock exchanges again. At least that is the most common explanation for this capital market anomaly. It is also possible that institutional investors will push prices up at the start of the year. Because they still have the risk budget for the entire year available in January, they can then access it with particular courage.

So should investors base their stock purchases and sales on the seasons? Better not: Seasonal stock market patterns can be observed in many years, but by no means in all. In 2018, for example, the Dax saw a sharp decline in the fourth quarter. It wasn’t until January that prices rose again. So there was more of a beginning of the year than an end of the year rally that coincided with the “January effect”. Anyone who bought shares in the summer of 2018 in the hope of rising prices at the end of the year had to wait around a year until the prices were back at the entry level.

Seasonal effects on the stock market don’t even have to fail completely in order to bring losses to investors who speculate on them. It is enough if they occur at a different time than expected. A summer lull can be observed on the stock exchanges for many years. The strongest month before the summer slump is by no means always May. Sometimes it’s April, June, or even July. Investors are therefore not always well advised with “sell in may”.

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