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Disconnect in the 'January Effect'

Stocks in this article: SPY TLT GLD

NEW YORK (FMD Capital Management) -- The "January effect" is widely considered to be a term used to describe an uptick in stocks after December tax-loss selling that lifts the markets.

However, in recent years there has been less of a focus on tax-loss selling because the markets have been in strong uptrends as we cross over into the new year. This may be a result of market participants becoming less focused on tax-efficiency and more attentive to economic data, corporate earnings, and equity momentum.

The SPDR S&P 500 ETF (SPY) shows that both December and January have had positive returns for the last three years. SPY was up 6.68% in December 2010 and 2.33% in January 2011; up 1.05% in December 2011 and 4.64% in January 2012; and 0.89% in December 2012 and 5.12% in January 2013. In December it was up 2.59%.

So far in 2014 the markets are slightly off their highs and have been choppy, to say the least. There is the potential that a correction will develop if corporate earnings underwhelm and trailing 2013 economic data miss forecasts.

However, there is also the opportunity for prices to consolidate and form a base that will resolve itself in the form of higher prices. I would not be surprised to see either scenario unfold and, as a trend follower, I am leaning towards higher equity prices until we see a substantive change in direction, volume and leadership.

The real beneficiaries of the January effect this year have been two different asset classes entirely. In 2013, investors wrote off long-term Treasury bonds and gold bullion as lost causes in the face of rapidly declining prices. Rising interest rates and improving economic data helped to spur billions of dollars out of fixed-income and commodities, which ultimately found their way into stocks.

The iShares 20+ Year Treasury Bond ETF (TLT) and the SPDR Gold Shares ETF (GLD) posted 2013 returns of -13.91% and -28.33%, respectively. However, both asset classes appear to have put in a short-term low and have been gaining momentum in the first weeks of 2014.

Treasury bonds have been spurred by a huge disappointment in payrolls data that are in conflict with the theme of an improving jobs outlook. This is one of the key indicators that Federal Reserve members are watching to determine how quickly they will taper their quantitative easing efforts.

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