The January Effect – What Is It?

As the end of 2013 approached you probably heard a lot of commentators talking about the “January Effect”.  No, this is not the feeling everyone in the Northeast has about relocating to somewhere warmer.  The “January Effect” is the market phenomenon that the stock market rallies in the month of January with a particular rise in small and mid-cap stocks.

There are several theories for the January Effect’s positive performance including:

– Investors selling losing positions in December to tax-loss harvest or offset taxable gains before year-end and then investing the excess cash in January.

– mutual fund managers becoming more conservative and taking less risk as the year ends, then becoming more aggressive in the new year.  In this case, small-cap stocks usually reap the benefits.

Research by notable professors Eugene Fama and Kenneth French shows the smallest 10 per cent of stocks averaged a 7.9% return in January from 1926 through 2011, versus an average of 0.9% in the other 11 months.  Large-cap stocks showed no such anomaly.

Of course, past performance does not guarantee future results and the historical trend has not been as pronounced in recent years.  Some additional reasons you would be ill-advised to put too much emphasis in the theory include fundamental economic and market conditions, tax harvesting occurring earlier in the year and increased transaction costs.

While the “January Effect” makes for interesting conversation and enjoyment at guessing what it actually means, the best investment strategy is based on your risk profile, time horizon and cash flow needs and not timing the market.

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