Like the groundhog, entire herds of investors stick up their head just after the end of January, and try to decide what the year will be like.  They are just about as accurate, generally. 

Groundhog day is thought to have its roots in old Teutonic Agrarian traditions in Europe, which evaluated the reactions of a Groundhog upon arising from its winter hibernation. If, on Candlemas, in the Christian Tradition, a recently arisen groundhog would be able to see its shadow, because the weather was dry and fair, it was a sign that the cold grip of winter had not yet broken into the wet spring that the farmers were waiting for.  If it was cloudy, wet and rainy, spring had arrived.  Otherwise the expectation was up to another six weeks of winter, which they called the “Second Winter.”  (Source: www.Groundhog.org)  So, just as a reminder, for those of us that want spring, shadow=bad news.

This is a charming, although unscientific approach to weather prediction, but hey, it’s fun, right?  Investors can occasionally follow the same logic in their decision making.  We are not, in the event, all that different from our ancient agrarian forebears, who tried to use whatever information they could to draw some conclusions about the near future.  One of the ways we manifest this peculiar behavior is known in investing circles as the January Effect. 

Investors “go all Middle-Ages” when it comes to prediction.

The January Effect, in case you haven’t heard of it, is a term coined by investment banker Sidney Wachtel in 1942.  His observation was that “As January goes, so goes the year.”  His premise that was after the tax selling and other operations to close out the previous year, investment firms would begin placing their assets in preparation for the next year in January, and choose either “safer” assets like bonds or “riskier” assets like stocks.  The trading in January would set the tone for the year as these decisions were implemented.  He published these observations in his paper entitled "Certain Observations on Seasonal Movements in Stock Prices," in 1942.  (Source: http://www.washingtonpost.com/wp-dyn/content/article/2008/10/02/AR2008100203726.html)

Since then, the debate has raged.  The theory has been amended, and refined.  It has been debunked and reinvigorated.  The current nuance to the theory is that you can tell whether large or small cap stocks would be the better choice, by evaluating January.  In 2004, a scholarly paper in Economics by faculty members at Taiwan National University and Ball State, entitled “Robust test of the January effect in stock markets using the Markov-Switching Model” tries to study this with a fairly rigorous methodology (Markov-switching).  They finds a compelling tendency that at least as small caps are concerned, there may be something to it.  (Source: https://cms.bsu.edu/-/media/WWW/DepartmentalContent/MillerCollegeofBusiness/Econ/research/FacultyPapers/liu2004jfma.pdf) However, for every quant trader out there ready to swear by this prognostication measure, there are at least as many detractors.  Observe a piece that was recently published on CNBC online—“The Mythical January Effect” which basically shows that January is fairly average, overall.  They take the perspective that something predictive should have a significance in absolute return itself.  After all, If a particular January is just mediocre, how can you infer something from it?  Is that good, or is it bad?  (Source: http://www.cnbc.com/id/102292114#.)

Of course, these analyses, while interesting reads, along with all of the other discussion on the topic, ignore a really fundamental principle about the world we live in.  Securities markets are nothing but an extension of a massive global economic system.  The system is so complex, and has so many interrelationships, and has so many self-organizing principles that a simple predictive mechanism is HIGHLY unlikely.   The debate overlooks the essential relationship between knowledge and the unknowable.  The future is manifestly unknown, and even leveraging all information processing currently available to us, it is completely opaque to us.  Yet, like the farmers in Europe who observed the Groundhog for clues about the future, we yearn for foreknowledge, for some glimpse into the future.   The interest in the January effect tells us a lot more about ourselves than it does the future of an asset class.  Some years it may work, other years it will not.  In the end, is it really worth the effort to try to figure out?  I don’t think so. 

Everyone should do themselves a favor this Groundhog day.  Tune in and see what the Groundhog has to say about the spring.  Have fun.  Look forward to spring, Just don’t look back at January.  

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NOTE: Investing involves risk including loss of principal.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

The prices of small cap stocks are generally more volatile than large cap stocks.