The January Effect
The so-called January effect refers to the hypothesis that stock prices perform comparatively better in the first month of the calendar year than in the remaining eleven months. Since this seasonality is incompatible with the efficient-market hypothesis, the January effect is frequently referred to as a capital market anomaly.
Where does the January Effect come from?
The effect was first demonstrated in 1942 by investment banker Sydney Wachtel. Nevertheless, the anomaly was only given increased attention in the 1970s and was subsequently addressed by various scientists in their studies.
However, the results of whether and, if so, to what extent the January Effect exists vary considerably depending on which period, which region and which asset class (large vs. small cap) was considered.
Historical data for the S&P 500 shows that, at least for the American market, no January Effect can be detected. In fact, the month even performs rather below average in comparison.
Source: Ginmon, S&P Dow Jones Indices
What are possible explanations for the January Effect?
The most popular of these is tax-loss harvesting. Behind this is the idea that investors sell loss-making shares shortly before the end of the year to offset these losses against gains made elsewhere, thereby reducing their capital gains tax liability.
These shares would then be bought back in January, which should lead to a noticeable rise in the stock markets.
Another popular explanation is what is known as "window dressing". This is the idea that professional fund managers try to spruce up their portfolios towards the end of the year.
This would lead to portfolios being reshuffled and shares that make the portfolio manager look bad being sold and replaced with supposed "winner stocks".
According to this theory, this process would lead to downward pressure on prices at the end of December, followed by a kind of recovery in January as soon as this pressure eases.
In addition, there are many other theories, including that investors start each new year with great optimism and buy more shares. However, none of the circulating explanations are free from criticism, meaning the picture remains ambiguous.
One well-known critic or sceptic of the January Effect, for example, is Burton Malkiel, bestselling author ("A Random Walk Down Wall Street") and former director of the Vanguard Group. Malkiel claims that seasonal anomalies like the alleged January Effect do not offer investors reliable opportunities.
Furthermore, he criticised that the transaction costs resulting from buying and selling securities would make the effect disappear.
Conclusion
Capital market anomalies like the January Effect are also viewed particularly critically in academia, as they contradict one of the fundamental principles of financial theory – the efficient market hypothesis.
According to this, share prices follow a so-called "random walk" and thus prevent the possibility of systematically achieving excess returns. Regularly occurring excess returns in January would therefore suggest a certain inefficiency in the markets.
It is therefore doubtful whether the January Effect is a truly regularly recurring phenomenon or whether it actually only occurs by chance in certain years.