The January Effect: Why Stock Inflows Are at a Record

Investors poured a record $58 billion into equity mutual funds and ETFs during the four weeks through Jan. 17, according to research by Bank of America Merrill Lynch. Of that amount, $23.9 billion was gathered during the final week of that period, the seventh-biggest week ever for equity inflows, Merrill Lynch adds. While most of the buying action has been directed towards passively managed investment vehicles, the four week period saw the biggest inflow for actively managed equity funds in four years, Merrill Lynch says in their Jan. 18 report, "The Flow Show: Happy New FOMO."

Defining FOMO

That stands for "fear of missing out," per Merrill Lynch. The S&P 500 Index (SPX) hit a new all-time high on Monday, closing at 2,832.97 for a robust gain of 6.0% for the year-to-date. Emboldened by strong stock market gains so far in the new year, investors are jumping on the equity bandwagon, as the fund flow figures cited above indicate. (For more, see also: Why Stock Investors Play the Risky 'Momentum' Game.)

The January Effect

What has come to be called the January effect is the seasonal tendency for stocks to rise in that month. From 1928 through 2017, the S&P 500 rose 62% of the time in January (56 times out of 90), per Yardeni Research Inc. The average gain was 1.1%. During the 56 times that the index rose in January, the average increase 4.1%, also per Yardeni, with an average loss of 3.9% in those 34 times that the index fell. January 2018 is on track to be the best opening month of a year since January 1997, when the S&P 500 advanced 6.1%, per

'Wings of Icarus'

The continued investor confidence in stocks is being driven by two factors, per Merrill Lynch: continued low interest rates and very high hopes for future corporate earnings. Earnings projections are getting wildly optimistic, with U.S. macro surveys cited by Merrill Lynch implying expectations of 20% U.S. EPS growth driven by U.S. real GDP expansion at a rate of 5% to 6%.

Meanwhile, Merrill Lynch's Bull & Bear Indicator stands at a value of 7.4, the result of "frothy price action." This indicator captures six measures of investor sentiment, and signals dangerously "euphoric" conditions when it reaches 8.0, per DominionFX. Those six measures are: hedge fund positioning; credit market technicals; equity market breadth; equity flows; bond flows; and long-only fund positioning.

Merrill Lynch dubs this section of their report the "Wings of Icarus," suggesting that the market is flying rather high, and thus may be set for a nasty fall. (For more, see also: Icarus Factor.)

Danger Comes in Threes

Merrill Lynch also reports that the consenus among their clients is that a stock market correction will commence only once all these things happen: forecasts of real GDP growth exceed 3%; wage inflation is more than 3%; the yield on the 10-Year Treasury Note is greater than 3%; and the S&P 500 moves past 3,000.

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