Disconnect in the January Effect

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The January effect is widely considered to be a term used to describe an uptick in stocks after December tax-loss selling that lifts the markets. However, in recent years there has been less of a focus on tax-loss selling because the markets have been in strong uptrends as we cross over into the New Year. This may be a result of market participants becoming less focused on tax-efficiency and more attentive to economic data, corporate earnings, and equity momentum.

The following table of the SPDR S&P 500 ETF (SPY) shows that both December and January have had positive returns for the last three years.

Dec-13: 2.59%; Jan-14: ??
Dec-12: 0.89%; Jan-13: 5.12%
Dec-11: 1.05%; Jan-12: 4.64%
Dec-10: 6.68%; Jan-11: 2.33%

So far in 2014 the markets are slightly off their highs and have been choppy to say the least. There is the potential that a correction will develop if corporate earnings underwhelm and trailing 2013 economic data misses forecasts. However, there is also the opportunity for prices to consolidate and form a base that will resolve itself in the form of higher prices. I would not be surprised to see either scenario unfold and as a trend follower I am leaning towards higher equity prices until we see a substantive change in direction, volume, and leadership.

The real beneficiaries of the January effect this year have been two different asset classes entirely. In 2013, investors wrote off long-term treasury bonds and gold bullion as lost causes in the face of rapidly declining prices. Rising interest rates and improving economic data helped to spur billions of dollars out of fixed-income and commodities, which ultimately found their way into stocks.

The iShares 20+ Year Treasury Bond ETF (TLT) and the SPDR Gold Shares ETF (GLD) posted 2013 returns of -13.91% and -28.33% respectively. However, both asset classes appear to have put in a short-term low and have been gaining momentum in the first weeks of 2014.

Treasury bonds have been spurred by a huge disappointment in payrolls data that is in conflict with the theme of an improving jobs outlook. This is one of the key indicators that Federal Reserve members are watching to determine how quickly they will taper their quantitative easing efforts. The Treasury bond market is anticipating that flagging economic data will lead to continued efforts to spur the economy through Fed intervention and lower interest rates. In addition, the uneven action in stocks has likely spurred a flight to quality in Treasuries as investors load up on instruments used to hedge volatility.

TLT

Gold on the other hand has eased its slide and appears to have found some value buyers that are looking for a turnaround in 2014. This may be due to investors looking to add to their gold positions and dig themselves out of the hole that they found themselves in last year. From a technical perspective, GLD has now formed a convincing double bottom on the chart and may be able to gain some additional upward momentum if it can clear the 50-day moving average.

The long term results of both TLT and GLD will likely hinge on the outcome of stocks this year. If we see an equity correction develop, there could be additional safety buying that spurs both asset classes higher. That is why I am continuing to hold several positions in select bond funds such as the PIMCO Income Fund (PONDX) that give my portfolio balance and act as a counter to volatility when it rears its ugly head.

My current analysis of gold is that it has yet to convince me that the trend has changed. I would like to see additional strength before I decide to re-allocate to this sector. Being early can prove to be more profitable, however it can also run the risk of piling up additional losses. To help mitigate that risk, I always recommend using a stop loss or sell discipline to define your downside.

It's still very early in the year to determine which way the winds will blow. However, I will impress upon you that changes in the market can happen rapidly which is why it pays to be on your toes and shift your asset allocation in response to new data or conditions.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs , Bonds , Commodities

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David Fabian

David Fabian

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