Among market anomalies, the “January effect” is one of the most famous. Stock prices would tend to increase significantly during the first month of the year, for reasons other than company performance. A phenomenon which, however, tends to fade.
According to the financial information site Investopedia, the value of the S&P 500 grew by an average of 1% in January between 1928 and 2019. The other months of the year saw an average growth of 0.2% during the same period.
“What we observe are the small cap stocks [actions de petites capitalisations] who are really going to have a growth spurt. Sometimes. And when we say sometimes, that means that it’s more than a coin toss,” explained Philippe Goulet Coulombe, professor in the Department of Economic Sciences at UQAM, in an interview with Duty last December.
“There are positions that were taken for tax purposes at the end of the year” which contributed to a rise in the markets in January, the expert said. This is called selling at a loss for tax purposes.
“In Canada, capital losses can be applied to capital gains,” reads a note from TD Bank. In this way, it is possible to reduce or even eliminate the tax payable on a capital gain simply by selling an investment with unrealized losses to offset the gain. This way you can save tax. »
It is the same mechanism that would explain the Santa Claus Rally, a market anomaly – if it really exists – meaning that the value of shares is boosted during the seven working days on the stock market after Christmas. It is also the first two days of January that would explain the Santa Claus rally. The “January effect” is the logical consequence.
In December, investors would sell their depreciating shares for tax purposes. These low-priced stocks would then attract bargain-seeking buyers, pushing prices higher. This hypothesis is, however, criticized, in particular because it does not materialize every year.
Psychological factors could also explain the phenomenon, according to a study by University of Kansas researchers Mark Haug and Mark Hirschey, published in 2006 in the Financial Analysts Journal. Many investors would like to exclude less performing companies from their year-end balance sheet to look good in front of their clients. This would contribute to the December sale and subsequent buyout, as would selling at a loss for tax purposes.
Market efficiency called into question
Market anomalies undermine investors’ confidence in the sacrosanct hypothesis of efficient markets. According to this theory, the price of assets in financial markets incorporates all available information. This implies that it would be impossible to “beat” the market.
However, before the 1990s, the month of January repeatedly had higher returns than the market as a whole. There would therefore be a flaw in the theory. “But it’s a correlation,” explains Mr. Goulet Coulombe. Years it happens, years it doesn’t. »
Moreover, when an anomaly becomes known, it tends to dissipate. First identified in the 1940s, “the ‘January effect’ appears to have essentially disappeared as it became known,” according to Investopedia.
Between 1989 and 2019, the average returns for the month of January were 0.4% in January and 0.6% in other months of the year. Additionally, the month of January has had positive returns in 17 of the last 30 years. Since 2009, it’s been every other year. The “January effect” would therefore have dissipated over time.
The January barometer
Another indicator that attracts attention at the start of the year, the more mystical “January barometer”. This indicator was first identified by financial analyst Yale Hirsch, himself at the origin of the Santa Claus Rally.
According to the barometer, the performance of the S&P 500 index in January would help predict its performance for the rest of the year. “I think it’s more of an adage than a real investment recommendation,” warned Philippe Goulet Coulombe on this subject.
The data appears to support his analysis. A negative performance of the S&P 500 in January is rare and the index tends to grow year over year. If the annual gain is positive after a favorable January, is it really “because” of the performance in January or simply a sign of the health of the economy as a whole?
The moral of the story, for the “January effect” and the “barometer”: a correlation does not necessarily hide a causal link. Let’s take it for granted.