Market Beat: Digesting the January Effect
December 16, 2011
TRUCKEE, Calif. andamp;#8212; The January Effect is a well-known and often-cited stock market anomaly, which has been studied for decades. The idea is that small cap stocks and stocks that performed poorly in the prior year will deliver superior performance over large cap and strong stocks in the month of January.The main reason behind the outperformance is that many investors will sell poorly performing stocks in December for tax loss purposes. All of this tax selling creates some good valuations which in turn will lead to outperformance in January once the selling pressure subsides. Another factor that may help lift stocks in January is because thatandamp;#8217;s when the Wall Street professionals get their year-end bonuses, and pensions typically invest funds as well.According to a study by University of Kansas professors Mark Haug and Mark Hirschey, from 1927 to 2004 small company stocks outperformed large company stocks by 2.5 percent in the month of January. In recent years that number has shrunk to about 1 percent and one of the reasons the return has declined lately is that once investors discover a market anomaly and trade accordingly, it becomes less effective. As you have more and more investors trying to scoop up bargain stocks at the same time and sell them, the buying and selling activity can act to reverse the January Effect. Literally hundreds of serious academic studies have now been done on it.There is another interesting market indicator related to the month of January, which is the andamp;#8220;first five days indicator.andamp;#8221; You may hear pundits say that if the market is up the first five days of January, then you can expect positive returns for the year. That is true to some extent, but can be taken out of context.Mark Hulbert of the Hulbert Financial Digest tested data on the Dow Jones going back to 1896 and discovered that if the market was up the first five trading days of the year, there was a 69 percent chance it would finish the year in positive territory with an average gain of 7.0 percent. What he also found was that regardless of what happened in the first five trading days, 65 percent of the time the Dow rose for the year anyway and the average gain was 6.7 percent. So statistically, thereandamp;#8217;s not much difference between what the normal expectation for the marketandamp;#8217;s return is and what happens in the first week of trading.Kenneth Roberts is a Truckee based Registered Investment Advisor. He has been a Truckee resident for 24 years. Ken has been in the securities business since 1992, has worked as a branch manager for a major Wall Street firm, and is currently a portfolio manager for Fusion Asset Management who specializes in target retirement and income producing portfolios. His has extensive experience using options as a portfolio management tool for both risk reduction and income production. Information on his money management service can be found at http://www.fusiontargetretirement.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before-purchasing any security.