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Why Next Week May Be Pivotal: Introducing The ‘JAJO Effect’
Submitted by FF Wiley of Cyniconomics
Why Next Week May Be Pivotal: Introducing the ‘JAJO Effect’
While this month’s stock market performance hasn’t been kind to the so-called January effect, this is hardly big news. Most analysts had already recognized that other months yielded better returns of late.
Take Burton Malkiel, author of A Random Walk Down Wall Street, who had this to say in 2003:
Suppose there is a truly dependable and exploitable January effect, that the stock market—especially stocks of small companies—will generate extraordinary returns during the first five days of January. What will investors do? They will buy on the last day of December and sell on January 5. But then investors find that the market rallied on the last day of December, and so they will need to begin to buy on the next-to-last day of December; and because there is so much “profit taking” on January 5, investors will have to sell on January 4 to take advantage of this effect. Thus, to beat the gun, investors will have to be buying earlier and earlier in December and selling earlier and earlier in January so that eventually the pattern will self-destruct. Any truly repetitive and exploitable pattern that can be discovered in the stock market and can be arbitraged away will self-destruct. Indeed, the January effect became undependable after it received considerable publicity.
True to Malkiel’s words, January is only the 8th best performing month (5th worst) for the S&P 500 over the past 25 years. Small cap results over the same period aren’t much different – January ranks as the 7th best month for the Russell 2000.
But what about other calendar effects?
We can appreciate Malkiel’s skepticism, but we’re not willing to reject all connections between investment markets and the calendar. There are other theories that aren’t as widely known or easily arbitraged as the January effect, which was first popularized way back in 1942. We’ll argue that one such theory may be more important than usual this year.
Our argument begins with four observations (we’ll get to theories in a moment):
- Market sentiment often changes during the earnings reporting season – in which most of the action occurs in the first month of the quarter – and these sentiment shifts tend to persist.
- Individual investors tend to pay extra attention to their positions early in a quarter, reacting to the past quarter’s results and then looking ahead to the next performance period.
- Professional money managers often refine their strategies prior to client reviews or board meetings, which typically occur after results for the prior quarter become available.
- Investors (individuals and professionals) are even more likely to rethink strategy in January, partly because it marks a new annual reporting period but also because it tends to be a time for planning and reflection. (How are you doing on those resolutions, by the way?)
These observations are admittedly vague, but we suspect they’re relevant to stock performance. They suggest that the first month of a quarter may set the market’s tone in subsequent months. In the context of today’s markets, they tie into a few questions you may be asking about early 2014 volatility: Is January’s market drop merely noise on the way to another string of all-time highs, or is there more to it than that? For instance, doesn’t it seem a little ominous that we stumbled out of the gates this year despite sentiment being rampantly bullish? Does this tell us to be cautious going forward?
If you happen to read the Stock Trader’s Almanac, you’ll connect our questions to the “January barometer” (not to be confused with the “effect” discussed above). The Almanac’s founder, Yale Hirsch, coined the term in 1972 when he presented research showing that January’s return is a decent predictor of full-year returns. He concluded: “As January goes, so goes the year.”
We’ll take a closer look at the January barometer below, while testing two variations drawn from the observations above.
“Downsizing” the January barometer
First, we doubt that any carryover of January’s performance is likely to persist for an entire calendar year. Based on the idea that quarterly reporting cycles may have something to do with these types of anomalies, it doesn’t seem right to think that January’s events should still be relevant near the year’s end. The first month of a quarter may offer clues about the next quarter or two, but probably not three or four quarters later after investors have shifted focus to subsequent corporate earnings and investment performance reports.
In fact, even without quarterly reporting cycles, you may still question why January would continue to be a “barometer” by the third or fourth quarter. You may expect to find lower correlations of January returns with the year’s second half than with the first half, and this is exactly what we see:
Note that the 33% correlation for the “downsized” January barometer is very high for these types of relationships. It’s comfortably significant based on traditional tests (the F-stat is 8.2). By comparison, the correlation of January’s return with the 11 months from February to December is still high at 28% but less significant (the F-stat falls to 5.1).
Here’s a scatter plot and trendline for the year-by-year results:
The chart shows that 54% of the years with negative January returns included negative returns from February to June (13 of 24), while only 9% of the years with positive January returns were followed by negative February to June returns (8 of 60). In other words, the probability of a down market between February and June was six times higher after a down market in January.
Do years or quarters hold the key to the calendar?
Second, we considered whether April, July and October also qualify as barometers, based on our speculation that the January barometer is partly explained by quarterly phenomena.
In particular, we calculated correlations with subsequent returns for all 12 months to see if the beginning-of-quarter months stand out:
Needless to say, the correlations fit the hypothesis, with the four highest belonging to January, April, July and October. The odds of this happening in a purely random market are nearly 500 to 1. Call it the “JAJO effect.”
Will JAJO spell an end to the market’s MOJO?
Only time will tell if the JAJO effect is reliable.
You may take a Malkiel-like perspective and say: “Okay, let’s assume 500 researchers test 500 hypotheses – at least one of those researchers is likely to find a result with 500 to 1 odds.”
And while that may be true, we think there’s more to it. If stocks don’t recover strongly by month’s end – say, back to the S&P 500?s 2013 close of 1848.36 – the odds favor continued weakness. As January goes, so goes the first half of the year.
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Well just wait until February rolls around and all the Central Bankers make their "whatever it takes" speeches and the MSM puts the propaganda into overdrive.
S&P 2,000 when it should be at 666.
How much are all the charts, historical examples, anecdotes, and technical analysis worth when the interest rates are 0% and Mr. Yellen has the pedal to the metal?
isn't the real problem the "JUJU effect"
Would not be surprised to see the Fed/government endorse investing SS in the market to ramp things up. Hey, unusual times call for unusual measures.
Small caps!
"The chart shows that 54% of the years with negative January returns included negative returns from February to June (13 of 24), while only 9% of the years with positive January returns were followed by negative February to June returns (8 of 60). In other words, the probability of a down market between February and June was six times higher after a down market in January."
What is this 'market' of which you speak?
I love ZH and TD but the only correlation here is that there is no correlation. At best all data points are 60% or greater against. These aren't batting averages or polling numbers. What I do see are the pilgrims who lined up to offer up their first-born on the altar of hope on the months before earnings were due to be released. BTW anyone else see the fish? And from the standpoint of meaningful statistical analysis or standard deviations, what else has been assumed is that the markets do not operate freely and independently of the Julian Calendar. There may be some basis there but would this be considered a nominal, ordinal, interval or ratio-driven data set? Monday morning expect to see hundreds of trading desks googling Madame Laveau and signing up for the Voodoo doll of the Month Club.
"The only correlation here is that there is no correlation."
Should suffice for another 100 points up of the S&P! ;-)
Are you alluding to a White Rabbit and the Queen of Hearts?
If you also factor rain, snow, who won the supeball and how many Friday the 13's in that year we go back to the original one word description. "Chaos"
Fundumentals and true valuations are no longer metrics you can believe and rely on.
Quite a bit since the world is based on comparable valuations. comps lead to correlations and everyone is a Top-down macro call now until Gov steps out of the picture (never ?).
Eugine Fama's students did plenty of work tracking risk adversity and seasonal investing habits. It's worth a good cold sunday 2 hours to read the top 4 google scholar market structure papers he co-authored.
The retail sell side pump that started in August 2013 is a good example of its relevance to modern securities strategy & reflexive thought. The August retail pump was a front-run on the traditional November Xmas pump. Retail sales analysts argued that the value gap should close between 18x growth leaders and 9x losers. Knowing the overlay, and plugging that into your reaction function is as valuable today as it has ever been before.
Some seasonal trades based on physical demand (lumber, oil, gas, coal yadda yadda) will always be around. However given the large storage costs associated with front running these trades or holding synth trades open cornering them is impossible both logistically and for margin risk-matching. Caveat is the Barings Bank case study.
I would argue that behavioural studies in asymetric investing will become more important in the next 5 years. It's important enough that the tier1 masters programs are adjusting the second year to have a E.History & derivatives components. CFA is also dropping a module into the new program allegedly in the rewrite. Most fund strategists have shifted from pure forward looking trend tracking like pre-2007 towards predictative signal models based around past events.
Where the book 'random walk' breaks down in the new normal is when he suggested that long-term index fund could generate superior returns to a professional manager over a 15 & 30 year period. This may still be true but this is heavily dependant on when fixed asset creation and per capita productivity were rising over the 1956-1978 and 1983-2007 periods. When the random walk stops walking upwards, then the whole concept of beating nominal inflation with passive indexing may fall flat. At least this has been the proof in Japan and Russia sofar.
Thank God it isn't the Jobu effect. That would be some nasty stuff.
http://www.funnyordie.com/videos/0f28d5f0d3/jobu-voodoo
Seems pretty plausible to me on a prima facie evaluation. Professional traders establish a position at the beginning of the quarter and spend the rest of the quarter defending that position. Then they readjust when new quartery data are released. Maybe high finance isn't quite as freewheeling, exciting, and difficult as Hollywood has led me to believe. Could it be that at bottom all those BOOYAH-screeming mountebanks really do care about the boring old market fundamentals? I'm guessing that they do, and that any pretenses to the contrary are nothing more than television kayfabe, or some sort of psychological compensation designed to develope and nurture a reckless alter ego (just like the predilection Boomers have for affecting a nonexistent Native American ancestry or dressing up like Tony Soprano).
The takeaway seems to be, "Don't follow the noise, follow your nose." Fundamentals always matter, even when they [apparently] don't. And this after all is nothing more than simple common sense. The performance of the market can not exceed the physical capacities of the environment. Physics supervenes on economics. Always has, always will.
Professional traders have no market to trade in anymore.
They are flipping coins that always comes up Feds.
I'm not sure WTF the "fundamentals" of this broader "market" are, but I can tell you what the fundamentals of the water situation in the West and in particular CA are, and how that reality is going to crush any fantasy of a recovery in this Country!
If people (without gardens) think they are paying anything less then 4x as much for food next year, as they did this year, they're dreaming!! This drought thats coming and water crisis, will be like nothing this Country has EVER seen!! 90% of the produce, fruit, and nuts consumed by Americans is grown in the Central Valley of CA with irrigated water and a very high % of the planets as well!
There is NO snow pack in the Seirra's on Jan 25th, during normal years, it's 25-40 feet of snow pack, and even on those years, the water consumption for Ag and residential has been drawing down the reserve every year!!
They're telling farmers to slaughter the dairy and beef cattle herds or move them east, as I type, or get ready to pay 4-10x more for water then they did last year, if they can get it! The produce growers in Salinas Valley are going to leaving hundreds of thousands of acres fallow, because they where just told this week, that they can expect 10% the water allocations next year, they got this year! Salinas Valley is where almost all the produce, fresh and frozen is grown in America!
It's not hype, it's not paranoia, this is going to happen, and it's going to be catastrophic! 165 million+ Americans are on welfare, disability, unemployment, or social security and 45 million more are children, who all have "fixed income" sources for food!!! Do the math, it's going to be unreal in human terms, and for all you ZHers, Who TF do you think will pay the tab and how???
Better buy more gold and silver.........and get your garden supplies bought soon!!
+1
Thanks for your insights!
Sounds like the central planner extraordinaire, Governor MoonBeam, should have been pushing desal instead of curly light bulbs & solar panels.
I mean, growing shit in what is essentially a fucking desert is great, until the water runs out...lol.
My produce comes from South Texas and Mexico. Not sure where you got your numbers. I quit eating stuff from CA when a lot of people got Salmonella from it.
Feel free to research it yourself, obviously new markets will open up as CA dries up next year, but shit will be 4x more expensive at least, and my guess is, there just won't be supply at all for most things grown in CA traditionally!
Get your garden planted!
Here is what I found about CA Ag after searching for 5 minutes!!!
No water for anything on this list, coming in spring 2014!!!!
Ranks first in total agricultural production.
Ranks first in total crops production.
Ranks second in total livestock & livestock product production.
Ranks first in production of almonds (100% of U.S. production).
Ranks first in production of avocados (96% of U.S. production).
Ranks first in production of broccoli (92% of U.S. production).
Ranks first in production of celery (93% of U.S. production).
Ranks first in production of dairy products (30% of U.S. production).
Ranks first in production of grapes (91% of U.S. production).
Ranks first in production of greenhouse/nursery (21% of U.S. production).
Ranks first in production of hay (14% of U.S. production).
Ranks first in production of lemons (89% of U.S. production).
Ranks first in production of lettuce (80% of U.S. production).
Ranks first in production of onions (31% of U.S. production).
Ranks first in production of peaches (54% of U.S. production).
Ranks first in production of pistachio nuts (100% of U.S. production).
Ranks first in production of plums (97% of U.S. production).
Ranks first in production of strawberries (83% of U.S. production).
Ranks first in production of tomatoes (73% of U.S. production).
Ranks first in production of walnuts (100% of U.S. production).
No problem, we have a replacement for that, it's called global trade, you need cash now?
I would also note that professional managers are more likely to be hired/fired on a quartly basis. I say this as somebody who has been in the industry.
Stocks go down in January
Stock market tumbles down the rest of the year
Does it really matter?
No, it doesn't.
Because money isn't what's going to take the system down. Money can be fixed by decree.
Oil is what will take it down.
What kind of people in their right mind would read this stuff. It's your day off bitchez. Use it wisely.
Crisis bitches! Part 2 I might add.
Not hanging in with the story line, however just like prior to WW2 the Nazi's rose to power out of hardtimes. Fascist Nazi"ism" seems to be picking up around the globe. Is this what the world wants?
I hope things will turn for the better, but as a realist, "I" we know that they will not.
Here is the latest from Spain.
http://www.typicallyspanish.com/news-spain/malaga/M_laga_city_is_to_hold...
Ever wonder why communists view Nazi's as facists and view themselves as defenders of democracy?
Because they are used to being controlled by the tribe, but not the state and corporations?
Definitely not corporations.
Corporations behave like little states.
They even have 'immunity' for the stockholders like the operators of nations.
Ooops.
Sounds a bit kookook mixed with numerology
My observation is that large institutional players are taking some of those 2013 gains off the table and shoving them back into bonds (Treasuries being an obvious benefactor of that). Not that there isn't reason for concern, but many of them had this in the plan before we even hit Jan 1.
Did they have HFT in 1972?
Nano second trading, phantaseconds, spoof fake orders at many thousands a second?
They did? Okay fair enough I believe, I believe.
Otherwise can you tell me the outside house temperature butter spreadablility in January compared to July and its correlation with the 'market'?
It will be fun to watch. Too bad I ddn't put more money into popcorn.
I'm a Virgo.
Anybody else notice that ZH has dumped the "South Korea To Hold Emergency Session" story that was on top a few hours ago?
Acting under orders? From who? Does ZH now being owned by ABC Media have anything to do with this?
There is some kind of algorithm, with rating, age of article, comments, ... that ranks these article's, I agree that sometimes they completely drop-off, but those are usually BITCOIN articles that get too close to the truth, e.g. there are a lot of HW BITCOIN mining advertisers here, and I'm sure when things get real ugly just threads drop down 3+ pages.
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I can't see a rational reason why ZH would drop a north-korea story, NK is the kind of dog that ZH loves to kick, and cannot kick back. There are NO advertisers on ZH that we know of? Or are there?
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ANother viewpoint is that the story was 100% BULLSHIT and that ZH pulled it out of embarassment. This is the likely reason for it to fall off the top so fast.
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Funny that we have to 2nd guess the tylers, in a real fight-club, we as all members of the club would be told the game.
4 weeks 1 day? Are crawling your way out of CNN unemployment toss? Looking to become the next zerohedge editor. No excepting applications. We OK.
It rolls with the hits, its digital, not like a paper scroll landing on the floor.
I've seen contributors posts "go away" at the top too and then re-appear at the top when people decided to comment later. Check out third (or fourth or fifth) from the top sometime, if the comments/tweets grow, they leap frog whatever is on top.
Everything-Is-Not-Conspiracy...its not "pulled"...I just commented there.
You don't have a fight club, it's completely your insane imagination.
It is still showing up as third from the top for me.
why such bad juju for jajo, jojo? can't we all just BTFD like the good old days?
thing is.....come a time.....it will be BTFD....and it'll keep dippin.....anhyone's guess as to when...but it's gonna happen....
TPTB have too much control. The only way the market falls is if they jerk the rug out or lose control.
Mr. Janet Yellen’s iron dome haircut will cock block any further fall in Dow Jones.
/sarc
"But what about other calendar effects?"
Seriously, it doesn't matter anymore and is not relevant. The markets are:
-Not made of people who "work" (see Retail Investors) for a living and are computer controlled with pre-determined and desired outcomes
-There is no "market" anymore to speak of, just rich institutions trying to fuck over each other by fractions of pennies in fractions of seconds
-Weather, workers, watchdogs, winning the future is all a joke and plays no role.
You are watching the circus. Stay calm and carry a big stick.
Is it possible to out game the gamers?
I have fun trying and some success.
Free point six percent projection.
http://www.imf.org/external/mmedia/view.aspx?vid=3068100643001
3.x percent off of the all time high and we are in a market crash?....
China could do something major to light the fire Sunday night...
The fed could postpone the the taper to keep it burning..... or even untaper
1875 S&P is not out of the question next week......
Earnings dont matter, real jobs dont matter..... the wealth effect is all that does matter.
Surreal but real.
Allow me to expand in the JAJO Effect. Love it or hate it, you’ll laugh.
Django Unchained: Django Guilt
The highest correlating month is April and the correlation is weak at best.