Replies to post #91 on augieboo's junk pile (augiejunk)

[augieboo]

The January Effect:
An Overview of the Debated Market Trend


Many investors have grown watchful of putting their money into stocks during the month of October given the market’s huge declines in October of 1929, 1987, and 1997. On the other hand, January has become marked as a month when stocks, especially small-company stocks, provide solid gains. Investors have picked up on the pattern and adjusted their buying and selling habits accordingly.

Three major market setbacks are clearly causes for October to raise investor concerns, but January’s investment history isn’t as eventful. Yet thousands of investors flock to equities in the first few weeks of each new year because of a phenomenon called the "January effect."

January Mutual Fund Performance, 1970 - 1999*
(Source: Wiesenberger/Thomson Financial, 1999)

 
 Fund Type   January Average Return    Number of Times Best Category     Percentage of Times Best Category  
 Small-cap    3.51%                    18 out of 29 years                 62%  
 Mid-cap      2.05%                    3 out of 29 years                  10%  
 Large-cap    2.17%                    6 out of 29 years                  20%  
 

*Wiesenberger/Thomson Financial notes that the effect was more prominent before the 1990s. January has not been the best month for any domestic fund category in the 1990s.

The name was coined by Donald Kiem in the early 1980s. In a graduate research paper at the University of Chicago, Kiem reported the exceptional returns of small-cap stocks during January in the years 1963 to 1979. Moreover, he found that the bulk of the outperformance occurred in the first week of the month. Today, Kiem, who is a professor of finance at the University of Pennsylvania’s Wharton School of Finance, says "…though it [the January effect] may be slightly smaller, it is still very significant statistically."

The trend continued beyond 1979 as January provided small-cap stock investors with investment returns above those of large company stocks (see chart above). Small-cap stocks also continued to perform better in January than they did during the rest of the year.

One of the more often cited causes of the January effect is year-end tax-loss selling. In this situation, investors create losses in some holdings to offset gains in others to reduce their tax liability. Then they buy back these investments or others in January. But Professor Kiem notes that because taxes are irrelevant for tax-sheltered investors this factor may have minimal influence.

Other explanations have centered around large asset inflows from institutional investors or year-end repositioning of portfolios by professional money managers. However, if institutional investors (such as retirement plans) were the only reason, then it would be reasonable to see the prices of large-cap and mid-cap stocks rise as much as small-cap stocks in January. Market history doesn’t support this theory.

The January effect has even been attributed to the old saying, "As January goes, so goes the year." Based on the Dow Jones Industrial Average, the month of January has been a relatively good barometer of the full year’s performance, but this is not always the case.

According to Lou Harvey, president of the Boston-based research firm, Dalbar, "The phenomenon for the most part is a self-fulfilling prophecy. Once the notion of a January effect became widespread, investors who do not want to miss the opportunity for above-average returns put available cash into the market, thus confirming the hypothesis that the market rises in January."

Harvey also notes social and psychological conditions present at the end of each year. "During the holidays, attention is given to family and friends and less to investments. This is evidenced by the lower volumes of market activity in the last two weeks of December. An upturn in January might be triggered by New Year’s resolutions to invest."

Some industry observers indicate they are seeing the anomaly begin to take place in late December and spill over into January. They maintain that if this continues to happen over time, investors will have to keep moving back into December to capture the performance jump. Eventually, they say, there won’t be any January effect.

Burton Malkiel, author of A Random Walk Down Wall Street and a professor of finance at Princeton University, is among those who believe that trends such as the January effect disappear as investors catch on to them. In a recent interview in Fortune Magazine (December 20, 1999), he said:

"Suppose we observe that the stock market goes up in the first five days of January. Then I buy the last day of December, and I sell the fifth day of January. If enough people do it, the market doesn’t go up the fifth day; it goes down because everyone is selling. Moreover, the market goes up the last day of December, so now you have to beat the gun by buying on the second-to-last day of December. Sooner or later there won’t be any January effect. I think any anomaly will eventually self-destruct. There are just too many smart people out there looking for them."

Fact or fancy, the January effect continues to be an interesting enigma for investors.

http://www.investoradvice.org/Articles/JanuaryEffect-sidebar.htm



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