CandleFocus Glossary Editor
The January Effect is the phenomenon in which stocks tend to rise in the month of January. According to data since 1938, an average yearly S&P 500 advance of 20% was seen in 29 out of 30 years of January-February gains. This effect is a result of investors engaging in tax-loss harvesting by selling losing stocks in December and buying back new positions in January. As this goes against the efficient markets hypothesis, some believe that January gains are slightly better than luck with 17 successes (57%) out of the past 30 years compared to 13 failures (43%).
While the January Effect was strong in the 1950s, the most robust January Effect was actually found in the 1990s when 88.1% of January gains were positive. Even with this increase in the 1990s, only 4 out of 15 years saw an average monthly return higher than the average return over the entire period (1.1% versus 0.7%). The January Effect may not be as significant as it was in the 1990s however due to the increase in tax-advantaged investments, such as 401(k)s, IRAs, and 529s, this has reduced the impact of losses due to tax-loss harvesting significantly.
In addition to tax-loss harvesting, other theories as to why the January Effect occurs include window dressing by investors, positive sentiment from analysts, and increased demand from pension fund allocations. Window dressing pertains to the tendency for companies to invest in the best stocks in order to exhibit the highest quality portfolio for their clients. Moreover, analysts’ reports may be more optimistic in January due to the New Year’s optimism. Finally, pension funds may allocate capital at the beginning of the year and increase demand for stock allocations.
In conclusion, the January effect is the tendency of stocks to rise in the month of January as observed since 1938. This can be explained by investors engaging in tax-loss harvesting, the New Year’s optimism of analysts, window dressing, or pension fund allocations. Similarly, the effective tax-advantaged investments have limited the effect of tax-loss harvesting in recent years.
While the January Effect was strong in the 1950s, the most robust January Effect was actually found in the 1990s when 88.1% of January gains were positive. Even with this increase in the 1990s, only 4 out of 15 years saw an average monthly return higher than the average return over the entire period (1.1% versus 0.7%). The January Effect may not be as significant as it was in the 1990s however due to the increase in tax-advantaged investments, such as 401(k)s, IRAs, and 529s, this has reduced the impact of losses due to tax-loss harvesting significantly.
In addition to tax-loss harvesting, other theories as to why the January Effect occurs include window dressing by investors, positive sentiment from analysts, and increased demand from pension fund allocations. Window dressing pertains to the tendency for companies to invest in the best stocks in order to exhibit the highest quality portfolio for their clients. Moreover, analysts’ reports may be more optimistic in January due to the New Year’s optimism. Finally, pension funds may allocate capital at the beginning of the year and increase demand for stock allocations.
In conclusion, the January effect is the tendency of stocks to rise in the month of January as observed since 1938. This can be explained by investors engaging in tax-loss harvesting, the New Year’s optimism of analysts, window dressing, or pension fund allocations. Similarly, the effective tax-advantaged investments have limited the effect of tax-loss harvesting in recent years.