January Dues – Undercover Economist

20th January, 2007

January was traditionally a good time to pick up bargains, on the stock market as well as anywhere else. This “January effect” was that US stocks rose much more in January than in any other month. Sidney Wachtel discovered the phenomenon in the 1940s, but it wasn’t until the 1970s that anybody took much notice. Subsequent researchers have made refinements and produced ingenious explanations, but the main interest in the January effect is as a challenge to the efficient markets hypothesis.

This hypothesis suggests you can’t beat the market without inside information. That’s because all publicly available information is taken into account in the market price. A rule which says “buy on 31 December and sell on 31 January” shouldn’t yield spectacular returns. But it has.

A simple way to understand the efficient markets hypothesis is to think about the problem of finding the shortest queue at the checkout. I never bother. The way I see it, if there were an obvious shortest queue, other people would have gone to stand in it already and it wouldn’t be the shortest anymore. Similarly, cheap shares have been snapped up and are no longer cheap.

But taken to extremes, the efficient markets hypothesis must be false. If it were impossible to beat the market then nobody would try, and if nobody tried it would be easy to beat the market. In other words: if nobody bothers to look for ₤50 notes dropped on the pavement, there will be more than enough lying around to justify the effort of doing so.

Yet the efficient markets hypothesis is much more convincing than it looks at first glance…

Continued, subscription free, at ft.com

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