What is the January effect? And more important, can YOU gain from it?
First I’ll explain what is the January effect then you will see what cause this effect and if it is only a myth? Or maybe it has some truth behind it, if so how will YOU be able to gain from it?
The January effect says that one can exploit higher returns on average in the stock market during January than the mean returns of other months of the year.
This phenomenon is known also as the “turn of the year” and relates also to the January barometer.
The January effect is perhaps one of the most well-publicized and discussed market anomalies in academic as well as in the professional literature (Jayen B. Patel, (2016)).
Even though it rejects the efficient market theory (EMH) that says that “asset prices fully reflect all available information, and it is impossible to “beat the market” consistently on a risk-adjusted basis since market prices should only react to new information or changes in discount rates (the latter may be predictable or unpredictable).” Wikipedia
This means that the markets are not truly efficient, and you can find all sorts of “calendar effect” anomalies like the Monday effect, the October effect, the Halloween effect, the December effect, and the May effect – “sell In May and Go Away”
Many researchers suggest that the January effect continues to exist in the stock market despite its popularity over the years.
Researchers report that the effect is noticeable mainly in small-cap stocks.
It does not affect the whole market.
Haug M; Hirschey M. (2006) reports in their seminal article tested equal-weighted returns and found persistent January effect for small-cap stocks in equal-weighted returns NYSE index that represented a simple average of the stock prices for all listed companies.
Lasser, D. J., Wang, X. 2015 found that arbitrageurs exploit the January effect when they can easily identify the losing stocks with the most tax-loss-sellers, that will be in good market years.
On the other hand, Jayen B. Patel, 2016 made analyses to several stock groups and indices, the U.S. stock market, developed and emerging stock markets as well as major regional stock markets from January 1997 to December 2014.
Their analyses clearly state January effect does not exist anymore in international stock returns, during high as well as moderate volatility periods in.
Additionally, their results also show January effect does not prevail when market conditions are bullish or bearish.
An ex-Director from the Vanguard Group, Burton Malkiel, who is the author of “A Random Walk Down Wall Street”, has stated that the January effect and other seasonal anomalies are not reliable to count on.
Furthermore, the January effect is so insignificant that the transaction costs make it unprofitable to exploit it.
The first explanation by most of the sources is Tax-loss selling; many investors are selling for tax purposes against profits at the end of the year.
Portfolio managers do not want to show in their year-end reports that they were holding stocks that did not do well.
For that reason, they sell such stocks and pressing the prices down.
In other words, professional investors seeking to eliminate embarrassing losers from their portfolios before the end of important reporting periods
The Wall Street bonuses
In January most of the corporate world gets their annual bonuses, and a big part of it goes to bargain stocks and drive up the prices of the stocks that were losers the previous year.
The investor psychology
For many people it is a good time to start saving for the New Year.
Well, it’s not that easy, but the guidance principle is to choose small-cap companies that hit hard, and are not at their highest, but at their lowest because when the year starts lots of investors take their annual bonuses and seeking for bargains.
You want to sell these stocks in mid to late January.
Once new investment starts coming into these stocks and rising the price higher.
For many people, the beginning of January will simply be a good time to invest for a couple of reasons.
Psychologically, the New Year is the perfect time to saving more money, it may be a New Year’s Resolution for some, or as I told you before, a way to put year-end bonuses to work.
Whatever the reason, it can cause to stocks to go higher at the beginning of January.
The January effect phenomenon has been observed in capital markets for decades. It is a well-documented market anomaly that has interested lots of researchers and studies.
As you saw from the “small” study I’ve made, in the recent time, it appears that many researchers indicate the January effect have either declined or does not exist anymore in major stock markets.
However, there are exceptions as the small-cap stocks some researchers indicate can still benefit from this popular stock market anomaly in global stock market returns.
I think, that this interesting stock market anomaly will continue to attract researchers and new studies as well as practitioners and traders that will continue to try to crack this magnificent anomaly in order to beat the markets.