The January Effect

The stock market is off to a very nice start in the first few days of the New Year. Some market technicians attribute this to the “January Effect” which describes a phenomenon in which stocks rally in the first few weeks of a new year. The buying is often attributed to investors who redeploy cash that was created from selling losing stocks in December. The selling is done to create tax losses that may be used to offset capital gains.

Given that investors often place the bulk of their savings in qualified retirement plans (IRAs, 401(k)s, 403(b)s, etc), one may wonder about the extent to which this “tax loss harvesting” actually occurs today.

It turns out that small cap stocks seem to benefit from the January Effect more than other stocks. Mark Hulbert, writing for Market Watch, points out that in all Januarys since 1926, small cap stocks have beaten large cap stocks by an average of 7%. The performance of large cap stocks in January is statistically indistinguishable from their performance during the other 11 months of the year.

The January Effect is a “market anomaly” - abnormal performance within the stock market that is contrary to the principles of an “efficient market.” Intelligent investors are very skeptical of such anomalies. If they were persistent, then smart investors would game the system and exploit them. This very action would eliminate the anomaly.