London: Beware of recency bias when you invest in emerging-market stocks in January. What seems like a new-year trend could be short-lived, data suggest.
In the past 21 years, investors who made full-year bets based on the first three weeks of trading lost money on at least 12 occasions as equities reversed direction in the fourth week and went the opposite way for the rest of the year. This suggests early January trading is often a spillover from the December sentiment and can be a contra-indicator of things to come.
This year, the MSCI Emerging Markets Index entered bull market after it crossed key technical thresholds in the middle of last month, buoyed by the prospect of a preliminary trade deal between the U.S. and China. That streak of optimism has taken the gauge to the highest level since June 2018.
Based on that, should investors pencil in a second-year rally in stocks, and even possibly the recouping of all trade-war-related losses? Not yet, history cautions. If a positive trend carries on beyond January 21 or thereabouts, then there’s a good chance it’s for real.
Here are the lessons from the past:
Dotcom Boom and Bust
In 1999, the MSCI gauge made a faltering start after the missteps of the previous year, including a debt default in Russia and a government collapse in Turkey. But the year ended up with a runaway rally as the dotcom boom peaked.
In 2000, the opposite occurred. Stocks kept advancing into the New Year, but a sell-off in late January was an omen of the dotcom bust that really began in April.
U.S. Recession in 2001
A massive rebound of 11 per cent in the first three weeks fizzled as the U.S. economy contracted.
Fed Stimulus-Led Rally
Even though the Federal Reserve had taken its benchmark interest rates close to zero and unleashed its first quantitative easing in the closing months of 2008, the pessimism surrounding the financial crisis lingered well into January. Emerging-market stocks slumped, before turning around and posting their best-ever annual performance.
Months before then Fed Chairman Ben Bernanke’s indication of a roll-back in stimulus came in the middle of 2013, emerging-market stocks had started their slide. But one would have scarcely guessed from the brisk start to the year.
China’s Yuan Shock
The year 2015 was a nightmare for China, and by extension, emerging markets. A stock slump in Shanghai, which the government worsened with strong-arm tactics and an unexpected depreciation of the yuan in August, took the wind out of investors’ sails. The year had begun positively enough, though, with a 2 per cent gain in the first three weeks.
A Bloomberg survey of money managers at the start of 2016 found most of them pessimistic about emerging-market stocks. Just weeks earlier, the Fed had hiked rates for the first time in almost a decade and that led to a sell-off of more than 13 per cent between New Year and January 21 - hardly a signal for the rally that followed.
A bullish start on the back of the previous year’s $3.9 trillion rally lost steam in the fourth week of January 2018. The reason: Donald Trump ignited his trade conflict with China on January 22 with tariff hikes on solar goods.
Truth be told, early January trading hasn’t always been a dud. It correctly predicted full-year moves on the following occasions:
The MSCI emerging-market equity gauge slipped 0.2 per cent on Friday amid rising tensions in the Middle East.