Mark Twain Warns about Investing in Stocks in January

Ok, we may have taken a little bit (a substantial amount) of liberty with that headline, but the statement isn’t completely false. Here’s the rest of what the great American Writer supposedly had to say.

“October. This is one of the peculiarly dangerous months to speculate in stocks in. The others are July, January, September, April, November, May, March, June, December, August, and February.” — Mark Twain

It’s one heck of a quote (we meant to write about it back in October but forgot), and got us to thinking about all the rest of those silly market sayings such as ‘Sell in May and Go Away’, ‘the January Effect’, and the currently in vogue ‘Santa Claus Rally’, per Forbes.

“Historically, December is a bullish month. In the last 100 years the Dow Jones Industrial Average has closed the month of December higher than its level at the start of the month on 65% of all occasions.  In the past twenty years the S&P 500 has done so 17 times…[tending to move] upward… late in the month. This buying spurt is known as the Santa Claus rally. Despite the name this market phenomenon is no myth…”

However, not all market journalists and analysts believe in the Santa Claus Rally like some of us, particularly Market Watch writer Mark Hulbert.

“Consider the stock market’s gain from Dec. 1 through its highest close during the month. On average, the Dow Jones Industrial AverageDJIA -0.06%   is 3.1% higher at that point than where it stood at the beginning of the month, according to a Hulbert Financial Digest study of the Dow since its creation in 1896.”

In fact, though, a 3.1% rally is below average. It turns out that eight other months — from March to July to October — have stronger rallies than December when their performance is measured the same way. The average Dow rally in all non-December months is 3.4%. So the market’s rally potential prior to Christmas is below average.”

There seems to be some debate however as to when exactly Santa Clause comes to Town. For you true believers out there, Jeff Hirsch editor in chief of Stock Trader’s Almanac says, the Santa Claus Rally only comes at the days following Christmas.

“As Hirsch conveys, since 1950, the S&P 500 has averaged 1.5% gains for that 7-day window. “Not a big gain, but a nice little positive,” is how he describes it. “There’s this general buying bias by the pros at the end of the year after tax-loss selling.”

What about after Santa’s sleigh is back in the barn (or does he store it in a hanger?), and the so called January Effect begins? A Seeking Alpha article does a sufficient job explaining our next trading myth.

“The empirical work of Jay R. Ritter finds th
at the ratio of stock purchases to sales by individual investors displays a seasonal pattern, with individuals having a below-normal buy/sell ratio in late December and above-normal ration in early January. Small stocks are typically sold by individual investors in December -often to realize capital losses- and then bought back in January. Jay R. Ritter documented that small-cap securities often have had higher rates of return than large-cap stocks in the January months in the 20th Century. As a result, theoretically, buying and selling behavior of individual investors at the turn of the year creates a great arbitrage opportunity to profit.”

So has this been the case the past 20 years or so? Seeking Alpha “Plays the January Effect,” and puts the numbers to the test.

“So I dissect the performance of the small-cap Russell 2000 Index (RUT) versus the large-cap Russell 1000 Index (RUI) through all Januaries between 1993 and 2000, to see that most of the “January Effect” actually occurred within the first month of the year.”

January Effect(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Seeking Alpha

Turns out of the past 20 years, only 10 out of 21 Januarys (47%) saw the January Effect come to fruition – just enough to question whether this theory is in fact a theory, or just a trading aphorism that people follow because it sounds cool.  Pair that with questionable accuracy and timing on the ‘Santa Claus Rally’, and these aren’t exactly investments you want as a core philosophy.  We’ll stick to low cost dividend paying index funds and a healthy dose of managed futures diversification, over ‘catchy saying market timing’ –  thank you.


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