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January Effect by Ufedolove: 2:42pm On Jan 01, 2019 |
What is the January Effect The January effect is a seasonal increase in stock prices during the month of January. Analysts generally attribute this rally to an increase in buying, which follows the drop in price that typically happens in December when investors, engaging in tax-loss harvesting to offset realized capital gains, prompt a sell-off. Another possible explanation is that investors use year-end cash bonuses to purchase investments the following month. BREAKING DOWN January Effect 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. January Effect Explanations 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. Studies and Criticism One study, analyzing data from 1904 to 1974, concluded that the average return for stocks during the month of January was five times greater than any other month during the year, particularly noting this trend existed in small-capitalization stocks. The investment firm Salomon Smith Barney performed a study analyzing data from 1972 to 2002 and found that the stocks of the Russell 2000 index outperformed stocks in the Russell 1000 index (small-cap stocks versus large-cap stocks) in the month of January. An ex-Director from the Vanguard Group, Burton Malkiel, the author of "A Random Walk Down Wall Street," has criticized the January effect, stating that seasonal anomalies such as it don't provide investors with any reliable opportunities. He also suggests that the January effect is so small that the transaction costs needed to exploit it essentially make it unprofitable. It's also been suggested that too many people now time for the January effect so that it becomes priced into the market, nullifying it all together. |
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