The Weekly Report: Utilising Market Enthusiasm

23 January 2012

Call it what you want: excitement, optimism or maybe just a short-term memory, but why do stocks still exhibit the January effect?

For those of you not familiar with the term or in need of a refresher; the January effect refers to a general increase in stock prices during the month of January. This rally is generally attributed to an increase in buying, which follows the drop in price that typically happens in December when investors, seeking to create tax losses to offset capital gains, prompt a sell-off (see: Investopedia). In essence, the effect is explained by window dressing.

However, the question remains: can the effect be applied here in the Caribbean?

One thing we can be certain of is that companies’ fundamentals do not change in an instant. So the January effect can hardly be linked to any sort of ‘organic’ growth. I can posit a few reasons for the early-year rally in U.S. markets which include but are not limited to positive jobless claims data, and some good Q4 2011 earnings results.

Of course, the impact of the European debt crisis of global markets has not diminished, but Italy, Spain and (very recently downgraded) France have all been able to conduct government bond auctions without much ado.  It may also be worth considering that the barrage of negative news in 2011 left investors with nowhere to look but up for 2012!

Nevertheless, cautious/watchful optimism continues to be the New Year’s mantra.

To relate to this rally regionally, we can use Guardian Holdings Limited (TTSE ticker: GHL) and Citibank (NYSE ticker: C) to illustrate this much-discussed (and at times much-maligned) effect:

From the end of 2011 to date, these stocks have risen by approximately 10% and 10.34% respectively. Limited data set? I totally agree, but take a look at a similar period for the previous year yourself.

Market efficiency and financial markets in the Caribbean unfortunately make for strange bedfellows. Inefficiency in the availability, dissemination, interpretation and utilisation of information allow for arbitrage: the reason many of us in the financial services industry have jobs.

Have you ever tried to value a local/regional corporate? I can safely wager that the “availability of information” has been the bane of your existence as an analyst or researcher. The January effect not only challenges the efficient market hypothesis, but the Caribbean experience nearly wipes out the theory altogether. Truly information-efficient markets would price in any window dressing, and January would be…well just another month.

Whether or not the effect is the result of habit or happenstance, its existence has been observed.

What does this mean for you? Given adequate research, some measure of technical analysis should figure into your investment strategy. While some argue that markets are increasingly efficient especially with the versatility of the internet, you can still capitalise on information-lags in the region. ‘Cleaning house’ in preparation of the new year is unlikely to change anytime soon.  However, one Reuters article which speaks to the January effect, has a much-needed caveat:

“One week doesn’t foretell what will happen the rest of the year. That trap ensnares a lot of investors. Past returns don’t guarantee future profits.”

The January effect can be extended to bonds as well, and Firstline aims to be your preferred choice as a dealer in new and established issues. We look forward to this wave of optimism being to our mutual benefit.

Gerard Stephens
Account Executive, Sales & Trading

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