The January Effect
In the world of investing, the basic questions investors want to know are, “Where should I put my money?” and “When should I invest?”. Within the financial world, entire departments inside banks, and even non-financial companies, are devoted to answering these two questions. Having the answers to these questions can yield significant returns on investment, and so firms put a great deal of time, money and effort into solving them. Not too long ago, the answer to the question of “when to invest?” may have had an answer. For decades investors observed an oddity in the market that reduced risk but occurred repeatedly. Unfortunately, it is largely believed this phenomenon no longer exists in our markets today. Despite this, it is still interesting to delve into the intricacies of such a lasting event.
Since 1938 the phenomenon known as “The January Effect” has been observed to provide returns above the average market return (Chen, 2021). This phenomenon has even been observed up to 1993 in the New York Stock Exchange (Haugen, R. A., & Jorion, P, 1996). The January Effect, simply, is the observed seasonal tendency for U.S. stock prices to rise during the month of January and into early February, especially mid-cap and small-cap stocks (Chen, 2021). Generally, the mid-cap and small-cap stocks will produce larger returns than the overall market, using the S&P-500 stock index as a comparison. Regardless, the January Effect suggests the overall stock market will rise, meaning an investment in the overall market in January will likely not have a negative return. This suggests that the safest time to invest may be during the month of January. Thus, the question of when to invest could have been answered by the January Effect until the phenomenon ceased to appear.
This phenomenon has been observed for decades but the causality behind it is largely debated. One popular hypothesis is the Tax-Loss Harvesting Hypothesis. This hypothesis attempts to explain the January Effect by suggesting that firms will sell off losing investments in December to claim losses for the tax year and then reinvest the capital in January, thus causing an abnormal return during this time (Sun, Q. & Tong, W., 2009). Another hypothesis suggests that January is a more volatile month due to the beginning of a new year and this added volatility causes smaller firms to have more risk, and thus also more reward than usual (Sun, Q. & Tong, W., 2009). Each of these hypotheses attempts to explain why a seemingly nonsensical market event occurs each year and both hypotheses do make logical sense.
However, the validity of both of these hypotheses has been disputed. For example, research into the validity of the increased-volatility hypothesis by Fudan University in Shanghai has reported there is not necessarily more risk in January than in other months. The research does find that there is higher risk compensation in January (Sun, Q. & Tong, W., 2009). So, there is no increased risk/volatility in January but there is higher risk compensation. This begs the question, why is there higher risk compensation in January than in other months and why does this occur every year? Overall, research into the January Effect may provide evidence against standing hypotheses but only add to the mystery of the phenomenon itself.
Unfortunately, the January Effect likely no longer exists in the modern financial era. Since the January Effect was initially observed in the 1900s, some comment that such a predictable phenomenon would surely have dissipated by now due to exploitation by investors or changing markets around the world. A study by the University of Cambridge in the UK decided to determine if this phenomenon still exists today. Using data from 2002-2017, the research found through statistical testing that the January Effect does not appear to be prevalent in most global markets during the aforementioned time period (Perez, 2017). In fact, the researchers concluded the effect may have dissipated. Overall, the conclusion of this research suggests the January Effect no longer exists in our time. Despite this conclusion, it is still interesting to dig into how this effect worked mechanically. Such a predictable event to have occurred in the markets for decades is definitely something worth studying on a detailed level.
Although the answer of when to invest may be gone, the practical effects of the January Effect may have only begun. As this phenomenon is studied, we are able to ask more precise questions into the mechanics of this event that occurred for decades. Discovering the mechanics can then lead to the practical application of them into our time to be used to help average-day investors get the best return on their investment. In short, the answers to the questions we ask about the January Effect could be very valuable, and more research can yield more answers.
* Edited by Andy Colando
Works Cited
Sun, Q. & Tong, W. October 23rd, 2009. Risk and The January Effect. Journal of Banking & Finance, 34(5), 965-974. https://doi.org/10.1016/j.jbankfin.2009.10.005
Perez, Gerardo. (2017). Does the January Effect Still Exists?. International Journal of Financial Research, 9(50), 50. http://dx.doi.org/10.5430/ijfr.v9n1p50
Haugen, R. A., & Jorion, P. (1996). The January Effect: Still There after All These Years. Financial Analysts Journal, 52(1), 27–31. http://www.jstor.org/stable/4479893
Chen, James. October 20th, 2021. January Effect. Investopedia. https://www.investopedia.com/terms/j/januaryeffect.asp
