While most of us are winding down after the whirlwind of the holiday season, some investors are gearing up for the annual “January effect.” This is the theory that, seasonally, stocks tend to rise in January more than in any other month.
It is a theory that has some basis in historical fact. On average, in records going back to 1928, stocks have returned 1.2% in January compared with an average of 0.6% in other months of the year, according to Dow Jones Market Data.
However, it seems that the more the January effect has become a truism, belief and reliance on it has declined and it is seen as a much more complex market anomaly ever in flux due to investor sentiment and market dynamics, and not the set pattern the descriptive jargon would appear to indicate.
Tracking the Effect
Economist and investment banker Sidney B. Wachtel first identified and named the January effect in his 1942 paper, “Certain Observations on Seasonal Movements in Stock Prices.” Using about 20 years of data, he observed that smaller stocks—which typically trade in lower volumes than large-company stocks—tended to rise and outperform their larger peers considerably in the first month of the year.
The leading explanation for the January effect is that many individual investors participate in tax-loss harvesting in December. This procedure involves selling losing positions to offset gains to reduce tax liability. After New Year’s Day, the theory goes, investors stop selling and replace the equity portfolios, leading to stock gains.
Another theory is that the January effect is behavioral and driven by consumer sentiment. Many investors may believe that the start of the year is the best time to begin investing for their future, with a clean slate. Bonus compensated workers and investors who may get paid either at the end of the year or the beginning of the following year (a Wall Street practice) become flush with investable cash early in the new year.
Is It Melting?
A later study in the Journal of Financial Economics in the mid-1970s, using data going back to 1904, showed gains several times larger in January than in an average month at other times of the year. This study found that an equal-weighted index of New York Stock Exchange prices average January returns of 3.5% compared with 0.5% for other months.
A Salomon Smith Barney study of market data from 1972 to 2000 found a smaller but still measurable effect. However, the effect appeared to have faded after 2000.
One recent study of market returns by fund manager Invesco found the S&P 500 returned an average 1.7% in January between 1928 and 2000—suggesting a strong January effect. But the rule hasn’t held up in recent decades, as the market actually posted returns of negative 0.3% in January between 2000 and 2023. Invesco found the same dynamic applied to small-cap stocks. These had returns of an average of 3.2% in January between 1979 and 2000, but only 0.1% during the first month of the year since 2001.
One theory as to why the January effect may have faded in the 21st century millennium is that the market is changing, with a bigger focus on mega-cap tech stocks. The shift began at the turn of the millennium, which coincided with the rise of indexing and exchange-traded funds.
There is another January theory called the “January Barometer.” This theory says that “So goes January, so goes the year.” In other words, the returns in January will predict the stock market’s overall performance for the rest of the year. Thus, if stocks rise in January, they will rise for the year and vice versa. Although some analyses have shown that this theory held up 85% of the time from 1950 to 2021, critics say the correlation is coincidental and evidence for this supposed barometer effect is scant.
It is important to note that the January effect is essentially an observation of past performance. As we all know, past performance does not guarantee future results. Once investors became aware of this January effect, they adjusted their strategies accordingly, which has decreased its influence as a strategy over time.
Conclusion: Do the Research
As long-term investors, Bowen Asset Management believes there is no substitute for doing your homework on an investment to determine its long-term prospects. Buy and sell decisions are not synchronized to a calendar but are based on in-depth analysis.
We believe Investments should be primarily based on understanding the underlying fundamentals of a company to be better equipped when making decisions during a January spike. A January spike whether you believe it or not, should be only part of the investment equation.
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Disclaimer
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