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Is the 'January Effect' Still Valid?

7 February 2013 - News - Editor

First observed by investment banker Sidney B. Wachtel in the early 1940s, the term the 'January Effect' is used to described a market anomaly where financial security prices experience an increase in the month of January. There are a number of reasons for the January Effect, with the most common theory being that individual investors holding small stocks may sell their stocks at year end, thereby allowing them to claim a capital loss for tax purposes, and then reinvest in the new year. Another reason suggested is that many investors who receive year-end bonuses in January use these bonuses to purchase stocks, pushing up stock prices.

In anticipation of cashing in on the January Effect, some investors buy stock at lower prices in the months prior to January, to sell it off in the new year at increased prices. This has some risk attached to it, as the January Effect is not necessarily a sure thing, as was the case in 1982, 1987, 1989 and 1990. Nonetheless, investors and analysts have seen January market performance as an indicator of what the rest of the year holds, and looking back through the history of the January Effect it has been noted that when January ended up, the rest of the year was nearly six times more likely to be positive.

However, it has also been noted that the January Effect is no longer as influential as it was in the past, as many investors who previously sold off stocks in December in order to create tax losses to offset capital gains, are now investing in tax-exempt retirement plans, and no longer need to sell off at the end of the year for tax purposes. Moreover, markets have adjusted to the trend, which traditionally had the most effect on small caps.

In January 2013, US stocks ended up 5.2%. This was their best start since 1997 and yet it appears not to have impacted the market as it would have in the past, which may indicate that investors have learned some hard lessons with regard to market volatility and unpredictability in the past five years or so. Whether the January Effect still holds true remains to be seen as the rest of the year unfolds.

 


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