People are asking the Big Q: What Is The January Effect?
The Big A: The January Effect is a seasonal increase in stock prices during the month of January.
It is attributed to an increase in buying, which follows the drop in price that usually happens in late December when investors, engaging in tax-loss harvesting to offset realized capital gains, prompt a sell-off. This year The Santa Clause Rally extended and Investors took profits on Monday, the 1st trading day of the New Year, and came right back in on Tuesday and the DJIA moved North from 30,230.2 to 31097.9 in 4 trading days, that roughly 900pts.
Note: A Santa Claus rally describes sustained increases in the stock market that begin on 24 December and extend through 2 January.
From Y 1928 through Y 2018, the S&P 500 rose 62% of the time in January that is 56 times out of 91.
The January Effect is a hypothesis, and like all calendar-related effects, suggests that the markets as a whole are inefficient, as efficient markets would naturally make this effect non-existent.
The January Effect seems to affect small caps more than mid or large caps because they are less liquid.
Since the beginning of the 20th Century, the data suggests that these asset classes have outperformed the overall market in January, especially toward the middle of the month.
Investment banker Sidney Wachtel first noticed this effect in Y 1942. This historical trend has been less pronounced in recent years because the markets may have adjusted for it.
Another reason analysts have begun to consider The January Effect less important as of Y 2018 is that more people are using tax-sheltered retirement plans and therefore have no reason to sell at the end of the year for a tax loss, like this year, the buying was stronger than the selling.
Beyond tax-loss harvesting and repurchases, as well as investors putting cash bonuses into the market, another explanation for The January Effect has to do with investor psychology.
Some investors believe that January is the best month to begin an investment program or perhaps are following through on a New Year’s Resolution to begin investing for the future.
Others believe that mutual fund managers purchase stocks of Top performers at the end of the year and eliminate questionable losers for appearance sake in their year-end reports, an activity known as “window dressing.”
Other evidence supporting the idea that individuals sell for tax purposes includes a study by D’Mello, Ferris, and Hwang (2003), which found increased selling for stocks that experienced heavy capital losses before the end of the year and more selling of stocks with capital gains after the start of the year.
Further, the trade size for stocks with large capital losses tends to decrease before year-end and increase for capital gains after the start of the year, which we saw at the end of Y 2020.
The investment firm
Salomon Smith Barney performed a study analyzing data from Ys 1972 to 2002 and found that the stocks of the Russell 2000 index outperformed stocks in the Russell 1000 index: small-cap stocks Vs large-cap stocks in the month of January seems we are seeing that action already in this New Year.
Have a healthy weekend, Keep the Faith!