According to a study published in the International Review of Financial Analysis, surging consumer sentiment in January has a significant impact on stock market performance for the rest of the year. The study reveals that investors typically adjust their equity allocations for monthly 401(k) contributions in January, determining how much of their payroll deductions go into stocks compared to other assets. While investors have the flexibility to alter this allocation at any time, the majority do so only once a year, specifically in January.
The researchers behind the study found that increases in consumer sentiment during this month result in a significant influx of cash into the stock market for the remaining 11 months. Surprisingly, no such correlation was observed for any other month apart from January.
Titled "The January Sentiment Effect in the U.S. Stock Market," the study was conducted by Zhongdong Chen from the University of Northern Iowa and Phillip Daves from the University of Tennessee, Knoxville. The professors discovered this January sentiment effect by closely analyzing changes in the University of Michigan's Index of Consumer Sentiment. Since its monthly update began in 1978, a substantial jump in the index from December to January has consistently foreshadowed above-average returns from February through December, and vice versa.
The January Sentiment Effect: A Bullish Start to the Year
The January sentiment effect has proven true once again, demonstrating its significance in the financial markets. In January 2023, the ICS reading saw a remarkable increase of 5.2 percentage points compared to December 2022. This monthly jump was larger than 91% of changes observed since 1978. In fact, it contributed to the S&P 500 SPX producing a total return of 18.8% from February through December 2023.
Looking ahead to 2024, the January sentiment effect appears even more bullish. The January 2024 ICS reading displayed an impressive surge of 9.3 percentage points from the previous month, placing it in the 99th percentile among all readings since 1978.
It is important not to confuse the January sentiment effect with the discredited January indicator, which suggests that the market's direction in January predicts its trajectory for the following 11 months. Unlike the January indicator, the January sentiment effect holds strong statistical significance, as I have recently argued.
Naturally, it is essential to recognize that no indicator, including the January sentiment effect, guarantees accuracy at all times. However, discovering a lesser-known indicator with a notable track record that displays such bullishness is certainly reassuring.
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