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The boost of a new year is something of a myth and faced with an already-shaky start, what should investors look to? Russ Mould goes on the defensive

October is probably the month most indelibly printed on the minds of investors, after the crashes of 1929 and 1987. But market lore also focuses on the first month of the year and the so-called ‘January effect’. This is supposed to see traders, fund managers and retail investors return to their screens refreshed after the Christmas break and pour fresh cash into the market, creating healthy early year gains for equities.

Unfortunately, a study by Shares of the FTSE All-Share index over the last ten years suggests the impact of the ‘January effect’ looks to be over-estimated. Over the period 1998-2007, no fewer than eight other months provide a better average return than January. More damningly, January has also generated a negative return for investors in each of 2000, 2002, 2003 and 2004.

However, there are two trends worth noting, even if the January effect looks to be more myth than fact.

Firstly, December has generated positive returns in nine of the last ten years. This could suggest the market has simply wised up to the ‘January effect’ and moved to price it in during the run-up to Christmas.

Secondly, even if bad starts to the year set the tone in 2000 and 2002, a bad January does not automatically spell doom for the rest of the year. Despite negative returns during the first month, 2003 and 2004 went on to offer overall annual gains of 16.3% and 9.1% respectively.

It is therefore way too early to write off 2008 as a bad job, although January has undeniably got off to a shaky start.

The Dow Jones fell nearly 4% last week after a grim batch of economic data was crowned by December’s jobs report, which showed unemployment reaching a two year high of 5%. Japan’s Nikkei-225 has plumbed 17-month lows in sympathy, as fears of a US recession continue to grow. Back home, early corporate trading statements have also had a bearish tinge to them. Retailers DSG International (DSGI) and Land of Leather (LAN), tech firms OCZ Technology (OCZ:AIM) and SimiGon (SIM:AIM) and industrial equipment auctioneer GoIndustry (GOI:AIM) all disappointed.

Investors should not despair. Energy support services expert, and long-standing Shares favourite, Cape (CIU:AIM) published an upbeat trading statement last last week, which noted the £277 million cap expects to beat analyst forecasts for the year.

This suggests investors will simply need to be as selective in 2008 as they had to be in 2007 to record a profit.

Last year, mining, basic materials, oil, oil equipment and telecom stocks massively outperformed, while banks, financials, retailers and real estate stocks were sectors to avoid at all costs. The fourth quarter was notable for a shift toward defensive sectors, such as utilities, tobacco and food producers, with oil again featuring strongly.

If the trading statements seen so far are any guide, with cyclically exposed sectors such as retail, tech and engineering taking a battering, this shift in sentiment toward defensive stocks looks set to continue through the early stages of 2008.

Shares says:

BUY BP (BP.), Cape, GlaxoSmithKline (GSK), Reckitt Benckiser (RB.), Tesco (TSCO), Unilever (ULVR)