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Beware the December mirage

By the Tetrad group

DOWN 1,86% on a weekly basis as at close of trade yesterday, the equity market has been bubbling aimlessly, seemingly changing down gears as the year-end approaches.

As is often the case when money is involved, people want explanations now on exactly what is happening.

Investors who had become used to the fat returns the ZSE has so far provided during 2005 feel the emotional urge for comforting explanations particularly keenly.

Likewise, the Doubting Thomases who, after missing the earlier bonanza, are locked in a titanic inner struggle with the forces of greed and envy within gradually gaining the upper hand over their inherent fear.

Both these types of people are constantly seeking reassurance from the talking heads that populate the investment circles this point is but a temporary dip and the good times are close at hand.

Which brings us to the so-called December effect.

The current theme in favour at this time of the year is that of the December effect. This is itself a cousin of the fabled January effect said to apply in the more developed markets.

Due to the favourable treatment applied to realised stock market losses by the US tax code, many investors choose to sell their losing positions at the end of the year and buy them back in the first week of January. Hence the market experiences abnormal gains during the first week of the year.

The local version goes something like this: during the last month of the year, the overall trend of the market will be downward as institutional investors look to balance their books by trimming down weightings in sectors/counters to which they are over-exposed and raise cash in order to meet their prescribed asset thresholds.

At the same time, the big individual investors will be trading very little as they are in the holiday mood and will also be sellers as they raise money for their holiday jaunts and school/varsity fees.

There is also the rather bizarre proposal that, in general, IT and human resources are physically and genetically hardwired to operate slower at year-end; so the market is similarly sluggish.

Apart from the last hypothesis, the rationale above are, all in all, very intuitive and convincing theories that you can confidently put forward to a favourite aunt without running the embarrassing risk of being labelled a dubious snake-oil salesman.


Except for one minor detail: the statistics do not bear this out.

Looking at a 15-year period stretching from January 1 1990 up till the end of 2004, the ZSE industrial index’s performance for December was negative in only six of those years.

Using comparative figures yields broadly similar results: the index’s December was lower than the average of the preceding 11 months for only seven of those 15 years.

Hence there have been more “up” than “down” Decembers in both absolute and relative terms.

The market actually beat its November performance in eight of the 15 Decembers under review – contrary to the said theory. This indicates a strong year-end on balance.

And remember, the “down” years include the watershed 2003 when the market lost nearly half its value in December after the new central bank governor’s dramatic shock therapy.

So in short, the December effect appears to be nothing but a mirage; a myth perpetuated by professionals in the sector who feel pressured to provide a simplistic reason for every gyration of the random walk that is the market.

In fact, in recent years it has become even clearer in the overseas market that there is indeed no January effect simply because no-one is able to profit from it.

The chartists’ explanation for this apparent extinction?

The market as a whole is aware of the January effect, expects it and adjusts accordingly. Such is the beauty of markets.

So a warning to all those who fall for the mirage and consider buying everything on offer out there at its “cheap” December price in order to make a killing when the share reverts back to its “normal” price in 2006.

It is exactly this sort of thinking that has built the multi-billion dollar fortunes of stockbrokers who scalp the unwary on entry and gleefully accept the commission when these very same investors realise their mistakes in the New Year and look to bail out.

In fact, despite what stockbrokers and purveyors of various trading systems will religiously say, humans have yet to devise a method that consistently beat simple, honest and thorough fundamental research combined with a strict adherence to the ageless know-your-your-company policy.

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