Any Truth to the January Effect?

The XAO defied my expectations falling -5.0% in January. As I've been saying since December, it is my belief that we will breach the lows made last November sometime this year. However I didn''t think it would be as early as January, the XAO falling to a new closing low of 3300 on January 23rd.

That new low was short lived and we have since rebounded a little more than 5%. However, whilst my prediction that the XAO would go lower in 2009 was vindicated, that brief fall below the November lows is not enough to convince me that the worst is over yet. So I'll be looking for the XAO to go lower still sometime in 2009.

Readers may be aware of a phenomenon in stock market lore called the "January effect" which goes something like the following; "as goes January so goes the year", which means if the market performs poorly in January it will do badly for the whole year and vice-versa.

This is one of those little nuggets of wisdom that seems to gain credence the more times it is repeated. However Mark Hulbert has a good article on why the January effect has little evidence to back it up based on US market data. Click here for the article.

Examining All Ordinaries data for the past 25 years shows that January finished down 10 times. Of those 10 times that January was a negative month the All Ordinaries was negative for the entire year on just 2 of those occasions, they being 1992 and of course 2008.

Interestingly of the 15 times that the XAO finished in positive territory in January, the market finished the year in negative territory 4 times. So somewhat ironically the market is more likely to be down for the year if January finishes up rather than down, based on that sample of 25 data points.

As usual though, we shouldn't put too much faith in the past when forecasting the future. So what will February bring? This much we know, the coming earnings season for corporate Australia will be bad, and that's putting it mildly, we will see numerous earnings disappointments and hear CEO's talk about poor outlooks for the remainder of the year.

We will also get a sizeable interest rate cut from the RBA as they will be forced to acknowledge a deteriorating economic environment and the spectre of deflation. I don't expect them to talk about deflation in their statement but they will defintely be thinking about it.

On the international front, the US will again provide us with some nasty employment data next week. The resolution of the good bank, bad bank proposal could give some short term direction to the market but at the end of day I again have to acknowledge that I have little insight into such matters.

However, I'll make a call that the XAO finishes lower in February as the bad news on the earnings and economic front continue to outweigh any positives. Also as usual, have a vote in this month's poll.