Is US Stock Market's 'January Effect' Real?

(MENAFN- Gulf Times) For decades, a popular theory has held that US Stocks tend to rise more in January than in other months. The existence of this phenomenon, known as the January effect, once appeared to be undeniable as studies showed gains several times larger in January than in an average month. The effect was most pronounced among small-company stocks from 1940 to the mid-1970s. But it seemed to shrink through around 2000 and hasn't been as reliable since.
What's the origin of the January effect theory?
The discovery of the January market anomaly is widely attributed to Sidney Wachtel, an investment banker who ran an eponymous financial firm and identified the January outperformance in 1942. Using about two decades of data, he observed in a published paper that smaller stocks, which typically trade in lower volumes than large-company stocks do, tended to rise and outperform their larger peers considerably in January.
Later research confirmed the anomaly, with a seminal 1976 study of an equal-weighted index of New York Stock Exchange prices finding average January returns of 3.5%, compared with 0.5% for other months, using data going back to 1904. A Salomon Smith Barney study of market data from 1972 to 2000 found a smaller but still measurable effect. The effect faded after 2000, according to several studies.
For three decades beginning in the mid-1980s, the Russell 2000 Index - a bellwether for small-cap stocks - averaged a gain of 1.7% in January for the second-best month of the year, according to data compiled by Bloomberg. But since 2014, the index has averaged a rise of just 0.1% for the month as the frenzy over mega-cap technology stocks such as Amazon Inc and Alphabet Inc gained steam.
What might explain the January effect?
The existence of the January effect was so accepted decades ago that most of the research focused on trying to find nuances and causes, without any firm conclusions. But there are theories. The leading one is that many individual investors conduct“tax-loss harvesting” in December, selling off losing positions to offset wins in order to reduce their tax liability. After January 1, the theory goes, investors stop selling and restock their equity portfolios, leading to stock gains. Another theory is behavioural: People make financial resolutions to start the year and shift their investments accordingly, boosting stocks. Many high-wage investors rely heavily on year-end bonuses, making them flush with cash to invest to start the year.
How is this January different?
US stocks got off to a volatile start in 2025, following a steep selloff in the final trading days of last year. The turbulence shows how markets are coming to grips with the Federal Reserve's plans to slow the pace of interest-rate cuts. That said, the Russell 2000 slumped 8.4% in December - its worst month since September 2022 - which may leave those battered shares poised for a rebound in the coming weeks. Small caps are projected to have double-digit earnings growth later this year; the companies typically benefit from rate cuts.
Are there other market theories about January?
Yes. There's the so-called January barometer, which is Wall Street folk wisdom positing that January's performance predicts the year's performance. (The term was coined by Yale Hirsch, creator of the Stock Trader's Almanac, in 1972.) The idea is that if stocks rise in January, they'll be poised to finish the year higher, and vice versa - such as in 2022, when a selloff that January was followed by a bear market later in the year. Although some analyses have shown that this theory held up 85% of the time from 1950 to 2021, critics say the correlation is coincidental, since stocks finished higher roughly three-quarters of the time during the same period.
There's also the“January trifecta”, which attempts to predict the year's performance by considering the first five trading days of the month, all of January and the so-called Santa Claus rally, a run-up in stocks around the Christmas holiday.
Why would the January effect have faded?
One theory is that markets have accounted for the January effect and adjusted to a degree that makes the effect undetectable. Another theory is that the market is changing, with a bigger focus on mega-cap tech stocks and that the change is muting the January effect. The shift began at the turn of the millennium, which coincided with the rise of indexing and exchange-traded funds at a time when investors were snapping up shares of the so-called“Four Horseman” of the late 1990s: Microsoft Corp, Intel Corp, Cisco Systems Inc and Dell. (Dell Technologies Inc was since taken private and then relisted on the stock market.) From 1979-2001, the Russell 2000 outperformed the Russell 1000 Index of large caps by 3.4% on average between mid-December to mid-February, according to the Stock Trader's Almanac. Since then, the Russell 2000 has returned roughly 1% more on average than its bigger counterpart.

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