What is the January Effect?
A common belief is that there is a general rise in securities prices during the month of January. This rise is hypothesized to be caused by an increase in asset purchases stemming from year-end tax considerations. Logically, this makes sense when factoring in how capital gains and losses are treated for tax purposes.
The History
The January effect was first noted by Sidney B. Wachtel in 1942 looking at data going back to 1925, he noticed that stocks in smaller companies were typically outperforming large companies in the first two weeks of January. Another study looking at data from 1972-2002 found that these smaller company stocks outperformed large stocks by 0.82% in the month of January. However, this very specific and small data point has been blown out of proportion by the media, many people today believe that the January effect causes the entire market to rise rather than small companies slightly outperforming large companies at the start of the year.
The Cause
A planning strategy exists whereby an individual with taxable investment accounts can sell positions with losses to offset the recognizable gains. This technique is known as “Tax Loss Harvesting” and is often utilized in December when the capital gains figures are released by the investment companies. From a cash flow perspective, it makes the most sense to sell your positions at the end of the year, closest to when taxes are due to ensure you have enough money to pay the taxes on these transactions.
Well, how does this affect January? A potential opportunity exists for buying securities at a discount during this period due to the decrease in price caused by the large number of investors implementing this strategy. If enough people do this, then it should cause a predictable pattern of a market downturn in December followed by a surge in January that can be timed and exploited for quick gain. Unfortunately, history is not always a predictor of the future, and this anomaly may not be relevant in today’s economic landscape.
What January can mean for you?
What we do know is that since 1938 there have been 31 years which saw growth in both January and February, 30 of those 31 years saw over 20% growth on average for the whole year. Even gains in January alone often signal a strong year ahead, going back to 1950 if January saw growth in the stock market, 87% of the time the market went up that year. Rather than trading around January itself, the January effect can be your barometer for the year ahead, trouble in January could indicate a rough year ahead, and positive returns could mean a boom.
Working closely with your competent financial advisor will help you navigate these issues and can be very prudent to your long-term investing success.
