For some, January is that month of the year when the slate is wiped clear, new plans are set and resolutions are made. It’s also a month that some hate, as we come down from the highs of the holidays. Ron Dahl was quoted as saying “if I had my way, I’d remove January from the calendar altogether and have an extra July instead.”  Investors are also split on whether to cheer on January or be wary of the month, mainly because of a long-held belief that what happens in January can often predict the course for the rest of the year. And, given the pullback this week, some are perhaps a little more guarded in their outlook for 2024.

 

As I have commented over the years, the statistical evidence behind the so-called “January effect” is that tight, though there are some interesting observations. Taking the S&P500 index, for example, since 1960 there have been gains in January 57% of the time – just slightly better than a coin toss. However, for those years where there was a gain in January, the year as a whole turned out positive in 86% of them. In only five years did a January gain see the S&P500 decline for the year.  Losses in January had little to no predictive power, with 48% of the years showing a loss for the index by year-end. That latter point should bring some solace to investors, should we actually finish this week on a negative note, which seemed highly probable at the time of writing.

 

 

That brings us to the question of just how well the first few trading sessions of the year predict what will happen for January? To get some insight, I simply ran the same analysis as in the January effect test, but this time I looked at the change in the S&P in the first four sessions against the actual performance for the month.

 

First, an alignment between the move in the index in the first week and net result for the month takes place the majority of the time, or 72% of the years since 1960.  This partially explains why traders place so much emphasis on the first few sessions.  But let’s break it down further.  Of those years, we ended up with a positive start and a positive January – about 65% of those years of alignment.  It’s not that the third of the time, when a weak start coincided with a down January, is insignificant; but again there is some comfort to be had.  A similar result shows up in looking at years where the beginning of the month gave a false clue as to what to expect from January. Since 1960, there were only 18 years where this mixed signal shows up, with negative performance in the first four days ending up with a good January only 7 times.

 

 

 

Okay.  So, we had a rough start to the year. Is there anything else in the tea leaves besides statistics that can provide investors with some warmth as these January winter winds blow? For one, we have to keep in mind that equity markets just came off a strong two months. From the closing low near the end of October, the S&P gained more than 16% right before New Year’s eve, and the TSX rose around 12%. That provides some context around this week’s slip. As for the TSX, this week hasn’t been that bad to begin with, thanks to strength in communications and energy. As clients know, we have begun to build exposure in the latter as valuations have become more attractive.

 

The surge in stock valuations towards the end of 2023 was based primarily on expectations for a swift pivot in the Federal Reserve’s restrictive policy stance, and the consensus started to build towards a first rate cut taking place in March. Fed officials have pushed back on that view, in both speeches this week and the latest FOMC minutes that were released on Wednesday. Throw in some signs of resilience in the U.S. jobs market and you get some chilly water thrown on the fire of perceived policy easing. It’s not that the probability of a March rate cut has dropped to zero, but if there isn’t a continuous parade of softer data between now and the January 31st FOMC meeting, it will be tough for Jerome Powell and crew to guide markets to said cut.

 

This morning’s U.S. payrolls report for December came in stronger than expected, with a gain of 216K on the month.  The year-over-year rise in average hourly earnings to 4.1% from 4% in November doesn’t look like much, but it is going in the opposite direction to what Fed officials want.  The initial reaction by both equities and bonds was negative, on back of the headline payrolls data, but we saw an improvement once participants factored in the net 71K downward revision to jobs over the past two months (meaning an effective payroll gain of 145K).  That said, even a number close to 150K is reflective of a buoyant economy and not one that is tipping over the edge.

 

 

At the same time, if we don’t get a March rate cut, it isn’t the end of the world either. Ally and I have been saying for a long time that calls for six moves this year was aggressive to begin with and that the bulk of any easing pattern would likely show up in the second half of the year. If we end up getting four cuts to the fed funds target, that would still be conducive for a continued rally in bonds, which should be supportive for stocks over the course of the year. As the above chart shows, the U.S. 2yr yield fell by close to a full point from October to the end of last year, taking us close to the 2023 lows created by the U.S. bank debacle. Against that backdrop, the 0.17% retracement this week is pretty minor.

 

Canada’s bond market has held in even better. After falling below 4% in December, the Government of Canada 2yr yield has backed up less than a tenth of a percent this week to 4.05%. While both Canada and the U.S. have seen a weakening trend in the major indicators since October (relative to economist forecasts), most attach a higher risk to Canada’s domestic economy as we begin the new year. Even if a March rate cut by the Fed has been put into question, the contraction in Canada’s economy in the third quarter and falling capacity utilization keeps the Bank of Canada in play. This morning’s December labour force report showed basically no change in jobs on the month, but full-time jobs peeled back by 23.5K. The sticky point for the Bank of Canada, however, will be the re-acceleration in the yearly growth rate of hourly wages for permanent employees from 5% to 5.7%.

 

Back before the holidays, Ally and I told investors that it would be prudent to take a little risk off the table and wait for a pullback to build exposure for the next leg of the cycle. This week’s developments suggest that we could see a retracement extend, though it may not be a protracted one, at least if the stats have anything to say about it.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.

   

Andrew Pyle

 

 

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.