Jingle Bells - the thing about beliefs

Many investors tend to look at the end of year with high expectation and hope. Those who lose money during a year keep believing that next year will be better. We keep pretending that it can’t be worse, can it? And probably many of us repeated the same formula at the end of 2007. Some of us even start counting chickens. It’s a rule of thumb that December must be better than any of eleven previous months. As such, we speak about window dressing, December, January effect etc. Plenty of investors have been disillusioned especially this year, judging that extremely profitable year since March combined with December and then January effects will bring abnormal returns. Let us see what the trend is over last ten years for seven markets perceived as global ones, from both developed and emerging countries.

Exhibit 1. December returns.

Indeed, the whole December story is not that short of reasonable basis isn’t it? I’d even say that investors believe so much in December that it’s been hardly possible to find any strong bear since 2003 (bar Russian Siberian bear of 2004, Polish Brown bear, American Grizzly and Japanese Black bear – all of exceptional 2007).

How serious is December effect? Statistician would say, results are significant. But come on, for them everything with chances greater than 5% is significant. I doubt, investors would agree with statisticians. Judging from Exhibit 2, on average, returns in December outperformed remaining 11 months during the year in last 10 years examined. However, it all depends on individual level of sensitivity. In case of Nikkei 225, December returns were better than returns in any other months during the year in 67% of cases. Similar ratio has been observed for FTSE 100, DAX and Bovespa. On the other hand, Micex December yield outperformed only in slightly more than 50%.

Exhibit 2. Number of months when index outperformed or underperformed in December during last 10 years.

What does it mean in practice? I’d say, that trading on the base of December effect is nothing more than something between randomness and luck. And with increasingly higher correlation between indices, investor are moving towards randomness even more than they think they are. And here we touch the magic of behavioural finance. At the end of the day it’s this warm feeling inside you that make you buy or sell. And when during the year it’s better time to feel good about life, money and investment if not during Christmas and New Year?

Be aware however, this year it’s going to be no Santa Clause in equities if not in the whole market. But this is a story for next blog which will follow soon. Not to end at bad note, there is always January effect. From what I can see, exactly the same story as December effect. But come on, we need to believe in something. All in all, this is what investment is all about!